Is $250,000 A Year Really "Wealthy?"

President Obama keeps saying he plans to pay for much of his new spending with taxes on the wealthy, but what should be considered "wealthy?" According to Obama's campaign speeches "wealthy" means families earning more than $250,000 a year, but $250,000 isn't worth as much in New York City as it is in Des Moines, Iowa. Many of these families are challenging Obama's assessment of what should be considered "wealthy," saying how they make more than that but are struggling to get by. Tim Iacono doesn't offer these families much sympathy, but looks closer at the situation in his blog post below.

There have been more than a few comments left here by readers over the years about families with big salaries and/or bonuses carping about how tough it is to get by on just a couple hundred thousand dollars a year in income.

Always of modest means, never having had to foot the bill for little ones around the house, and having avoided living and working in the Bay Area, my view of things is probably a bit slanted in the other direction but, to me, a quarter million dollars a year looks to be a huge opportunity to sock money away for retirement.

Via the Wall Street Journal comes this tale of the difficulty some have in making ends meet.

Ellen Parnell and her husband, Donald Parnell Jr., seem like the kind of well-off couple President Barack Obama has in mind when he suggests raising taxes on families earning more than $250,000 a year. A surgeon at Fort Sanders Sevier Medical Center in Sevierville, Tenn., he drives an Infiniti. They vacation at a beach resort every year.

Yet, right now he is working seven days a week. The car is more than a decade old, the vacation home in Sandestin, Fla., comes at a moderate weekly rate because members of Ms. Parnell's extended family own it. Her family of five would like more room than they have in their 2,500-square-foot home, yet they can't afford anything larger. The downturn has them skittish about paying for renovations.

While not familiar with the local real estate market at all, clearly, you can get a lot of house for not too much money in Sevierville.

The story continues:

"I'm not complaining, but the reality is Obama may call me wealthy, but I thought we were just good old middle class," says Ms. Parnell. "Our needs are being met, but we don't have a load of cash to cover wants."
...
Wealth and comfort "depends on where you're coming from," said Lois Avitt, a sociologist and founding director of the Institute for Socio-Financial Studies in Charlottesville, Va. To a family earning $50,000, $250,000 is well off, but for the family earning $250,000, rising college and medical costs and dropping home values make the perception debatable.

The reasons for the insecurity are that net worth is declining at the same time that expenses like education and health care, two of the biggest concerns cited by members of that income group, are going up faster than wages and income, says Heidi Shierholz, an economist at the Economic Policy Institute in Washington. "Those are the biggies. They are huge parts of the set of middle-class aspirations, and the prices of those have increased way faster than income." The bursting of the housing bubble makes that more stark.
...
San Jose, Calif., Mayor Chuck Reed calls a family living in Silicon Valley earning $250,000 "upper working class." That is about what two engineers working at a technology firm can expect to make, but "a family earning $250,000 a year can't buy a home in Silicon Valley," he said.

James Duran owns a human-resources company in Silicon Valley and is president of the Hispanic Chamber of Commerce in California. He supported Mr. Obama, but is worried about the tax proposals. He has laid off some employees in recent months and has been wondering how he can fund an extension of those workers' health-care benefits.

Mr. Duran said he and his wife earn about $400,000 annually, but "I'm barely getting by." They have high property and state taxes, as well as college tuition and savings to cover. "I'm an Obama man, but this side of him is a difficult pill for me," he said.
...
For the Parnells, their perception of themselves is based on the math. The value of their house is down $60,000. Ms. Parnell says the couple's gross income last year was about $260,000. Taxes, premiums for medical care and deductions for Social Security and their 401(k) contributions cut the gross to about $12,000 per month. The family tithes $1,300 a month at their church. Their mortgage, second mortgage and payment on land they bought is nearly $4,000 a month. Other expenses, including their family car payment, insurance and college funds, as well as basics like food, utilities and donations to charities, leave them with about $1,200 left over each month.

"I'm not after sympathy. We are blessed. What I want is a reality check on what rich means," Ms. Parnell says. "I can pay my mortgage and I can buy some clothes. I'm not going without, but I'm not living a life of luxury."

The Parnells should probably take a basic personal finance class or two and many of their problems might quickly be solved - that $4,000 a month in mortgage payments for a house that's too small, and some other property, should have set off alarm bells long ago.

Also, that top line of $260K that erodes to $144K after 401k contributions, medical care premiums, and taxes sounds a bit excessive - you can quickly get to about $40K for the first two items leaving their tax hit at $75K.

Does that sound right?

It's a good thing Ms. Parnell is not asking for sympathy because she's not likely to get any.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

American's Worth Less Than In 2001, And It Is Getting Worse

According to a recent Federal Reserve report American's are actually worth less today than they were in 2001. Well known economist Paul Krugman blames the American tendency to spend instead of save for limiting our net worth growth, which should be of little surprise. Now it appears that this trend is ready to reverse, which will only exacerbate the economic problems the country is facing. Krugman also makes an interesting comparison to the Great Depression, and how we eventually were able to escape it. At the end of the day, though, he doesn't see the outlook for the economy as very good at all. Economics professor Mark Thoma looks at Krugman's article in his blog post below.

Do we have what it takes "to boot the economy out of a debt trap"?:

Decade at Bernie’s, by Paul Krugman, Commentary, NY Times: By now everyone knows the sad tale of Bernard Madoff’s duped investors. They looked at their statements and thought they were rich. But then, one day, they discovered to their horror that their supposed wealth was a figment of someone else’s imagination.

Unfortunately, that’s a pretty good metaphor for what happened to America as a whole in the first decade of the 21st century.

Last week the Federal Reserve released the ... latest ... report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation ... since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers. ... Why should we have expected our net worth to go up?

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. ... Then reality struck... The surge in asset values had been an illusion — but the surge in debt had been all too real.

So now we’re in trouble — deeper trouble, I think, than most people realize... For this is a broad-based mess. Everyone talks about the problems of the banks... But the banks aren’t the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

And as the great American economist Irving Fisher pointed out in the 1930s, the things people ... do when they realize they have too much debt tend to be self-defeating when everyone tries to do them at the same time. Attempts to sell assets and pay off debt deepen the plunge in asset prices, further reducing net worth. Attempts to save more translate into a collapse of consumer demand, deepening the economic slump.

Are policy makers ready to do what it takes to break this vicious circle? In principle, yes. ... In practice, however, the policies ... don’t look adequate to the challenge. The fiscal stimulus plan, while it will certainly help, probably won’t do more than mitigate the economic side effects of debt deflation. And the much-awaited announcement of the bank rescue plan left everyone confused rather than reassured.

There’s hope that the bank rescue will eventually turn into something stronger. ... But even if we eventually do what’s needed on the bank front, that will solve only part of the problem.

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom.

Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely. The odds are that the legacy of our time of illusion — our decade at Bernie’s — will be a long, painful slump.

[Note: James Kwak has balance sheet calculations based upon the Federal Reserve report showing the severe deterioration in household balance sheets.]

This post can also be viewed on economistsview.typepad.com.

A Christmas Wish For Your 401(k) Account

Most people lost a good portion of their 401(k) this year, but will next year be any better? Most people would have to say yes, if for no other reason than it would be hard to comprehend anything being worse than 2008 was. Already analysts are predicting much stronger earning next year, but then we are hearing reports about how horrible this holiday has been, and how that is going to kill some companies. So can we expect a Christmas gift this year for our 401(k) and other retirement accounts? James Picerno from The Capital Spectator offers up his insight below.

U.S. corporate earnings have been under pressure for some time, based on reported operating earnings for the S&P 500. Indeed, the bloom fell off the rose a year ago, when S&P earnings took a dive in 2007's fourth quarter from the formerly plush levels.

A lower level of earnings has prevailed ever since, as our chart above shows. But bottom-up estimates (as per Standard & Poor's as of December 16) are decidedly upbeat for 2009. If the forecast proves accurate, by this time next year S&P 500 operating earnings will return to the record levels posted in 2007. If such an earnings rebound is coming, the S&P 500 looks inexpensive based on the forward earnings multiple of 10.6, as per the full-year 2009 earnings estimate of $83.44.

Reuters reports that a key source of the expected earnings turnaround next year will come from none other than the ailing financial sector. That would be no trivial rebound, considering the current depth of earnings red ink weighing on the financial sector. But that will give way to positive earnings next year, or so we're told.

Consumer discretionary sector earnings are also thought to be poised to soar next year, rising 46% for full-year 2009 earnings, based on bottoms-up predictions. That's nearly twice the S&P 500's predicted earnings rise. In fact, only the energy, industrials and materials sectors of the S&P 500 are expected to suffer lower earnings in '09 vs. this year. The other 7 sectors for the S&P are on track for higher elevations.

It sounds like just the holiday treat we've been waiting for. Yet we must be wary of analysts bearing gifts. Indeed, bottom-up analysts as a group tend to be more optimistic relative to top-down analysts. Even so, the top-down crowd sees earnings growth for next too. The high end of forecasts among top-down calls for a rich $100 for 2009 S&P earnings, vs. $60 on the low end for this group's prediction, The Wall Street Journal recently noted.

For what it's worth, your editor is also confident that next year's earnings for the S&P will rise above this year's dismal results. But that's like saying Wall Street's bloodbath won't be so bad in 2009 vs. the last few months.

One of the few bright spots about life after the apocalypse is that a rebound of sorts is virtually guaranteed. Timing is always a question, of course, but rebounds eventually arrive. But no one should confuse a bounce off the bottom as a sign that a return to trend is imminent for corporate earnings. The economic headwind promises to be quite stiff next year, and it remains to be seen who'll have the stamina and the savvy to weather the storm.

Yes, government stimulus will be an increasingly positive force as next year unfolds. But unless you're expecting miracles, it's best to keep the celebratory champagne on ice for the foreseeable future. It took us years to get into this mess, it'll take more than a 2 or 3 quarters to get us out. That doesn't preclude a bounce, but repairing the damage this time will take more than running the printing presses at full speed.

This post can also be viewed on capitalspectator.com.

Are Private Loans Suitable For Your IRA?

One of the advantages--also, in fact, a potential disadvantage--of a self-directed IRA is that there are a plethora of investment opportunities to choose from. Today we are specifically going to look at private loans. Private loans are loans made from an individual to another, so no banks are involved. In terms of private loans as an investment vehicle, there are, of course, pros and cons.

Private loans can potentially provide investors with substantial returns. Typically, borrowers turn to private loans--knowing they are going to be more expensive than traditional bank loans--because they can’t qualify or don’t have time to wait for bank loans. Again, this can present both a risk and an opportunity for investors. In addition, private loans can also be secured against assets--including most notably including real estate--helping to minimize risk factors.

Investors considering private loans need to take several factors into account. First off, they need to make sure to judge the adherent risk involved with the particular loan accurately. There is a reason these borrowers are turning to private lenders for money, and investors need to find the balance between risk and return. Secondly, banks make their money by lending money; they have the process and paperwork down to a science. They know exactly what they need to do and what they need to have the borrower sign in order to ensure that they have maximum protection under the law. As a private investor you would be wise to do the same. Make sure your contract is good and that you are taking all necessary steps to validate the contract. If it needs to be recorded at the court house, make sure that gets done, and so on. Lastly, private investors need to understand what to do if the borrower defaults. What process do they need to follow in order to collect? With private loans made to friends or family this part becomes especially hard to swallow, but if investors are truly looking out for their investment, they need to take appropriate action.

Now let’s look at some of the things self-directed IRA investors need to keep in mind when investing in private loans. One of the biggest factors that self-directed IRA investors need to understand is the prohibited party rule. When investing your self-directed IRA funds, there are certain people with whom you are not allowed to deal. According to the IRS the following people are all disqualified:

1. The IRA owner; his or her ancestors (i.e. parents, grandparents); his or her lineal descendents (i.e. children or grandchildren)
2. The spouse of the IRA owner
3. Financial advisors and other fiduciaries
4. Any entity owned 50% or more by a disqualified party (such as a business half-owned or more by the IRA holder’s daughter)

If you deal with any of these people, you are going to be in direct violation of the rules and will be heavily penalized. Outside those mentioned above, you are able to deal with who you wish, however remember this next point: As the person in charge of your IRA’s investments, you have a fiduciary responsibility to the IRA. That means that if you decide you want to lend money to your brother, girlfriend or anyone else with whom you have a relationship, you are required to put the best interest of the IRA ahead of your relationship. If your sister defaults and you don’t send her to collections, the IRS could find that you’ve violated your responsibilities and still hit you with all the penalties. This is not a situation you should take lightly, so as a self-directed IRA lender, you need to make sure that if you lend money to someone you have a relationship with, you are willing to do what is necessary to act in the best interest of your IRA. Make sure they understand this upfront, too, so that if push comes to shove, the will be prepared.

Another thing to keep in mind when investing in private loans with your self-directed IRA is that loans are not always liquid. Make sure you are aware of the mandatory distribution rules (required distributions start at age 70.5) as well as when you might need to access those funds for retirement expenses.

With that in mind, if you take the appropriate precautions, private loans can be a great investment for their IRA. Personally, if I were making private loans in my IRA, I would limit them to secured loans (preferably real estate) at fairly low LTVs. I want to know that the money in my IRA is safe and secure, but I also want to see it grow. Done correctly, private lending can achieve both those goals. Compared to what is going on in the stock market and real estate markets right now, making private loans seems like a pretty good option. If you are making real estate loans right now, though, make sure the LTV is low enough to account for possible value loss.

One telling sign as to the validity of private loans within self-directed IRAs can be found in a client survey done by Guidant Financial Group recently, in this survey they found that private lending within self-directed IRAs had increased 131 percent since 2005. That’s a huge increase in self-directed IRA private loan activity, and in today’s market I certainly can’t say I blame them.

Social Security Benefits: Apparently We Have Nothing To Worry About

I read an interesting article yesterday from MarketWatch that said all the talk about the failing Social Security System, and how it is going to soon run out of money is completely overblown. According to the author, Dr. Irwin Keller, the social security system may never run out of money, let alone run out of it in the near future. He claims that people are reading only the summary page from the annual report issued by Social Security’s board of trustees, which offers a warning of the possibility of a shortage in funds, and that if people read further they would see that the projections used in predicting the fund shortage scenario are drastically conservative. Using growth projections that are more historically consistent, the fund would actually never run out of money.

This is an interesting view, but I’d like to point out one thing that he neglects to mention: there is no money in the Social Security system right now. All that’s there is a bunch of IOUs from the U.S. government that they plan to pay back to the supposed trust fund. Let’s look at some quotes from President Bush himself in an MSNBC article a few years back:

“’A lot of people in America think there is a trust—that we take your money in payroll taxes and then we hold it for you and then when you retire, we give it back to you,’ Bush said in a speech at the University of West Virginia at Parkersburg.

‘But that’s not the way it works,’ Bush said. ‘There is no trust ‘fund’—just IOUs that I saw firsthand,’ Bush said.”

The article goes on to explain that the so called “trust fund” is actually a white notebook filled with physical evidence of a couple trillion dollars worth of Treasury Bonds.

We have loaned our retirement funds to the U.S. government—the most indebted country the world has ever seen—and the government doesn’t have the money to pay us back. Of course they can print more money to pay us back, but the actual buying power of currency will likely be far less than what we put into the account in the first place. Even if we get our full Social Security benefits, as Keller argues we will, in reality the value of those benefits will have been drastically reduced.

Personally, I’m a big fan of moving at least a portion of our Social Security benefit payments into an investment account that is controlled (at least somewhat) by the taxpayer. I wouldn’t hire a financial planner with the spending habits of the government, and I certainly don’t want them in charge of my retirement money. The more control I have over my Social Security benefits, the better I will feel. I hope that Keller’s assessment is correct, but I’m certainly not counting on it. I suggest you not plan for your retirement with the assumption that you will get your full Social Security benefits either. It is far better to be pleasantly surprised and have extra than to count on your full Social Security benefits and not have enough money for retirement.

Real Estate IRA: What Is It? Which Type Is Best?

A real estate IRA is just another name for a self-directed IRA. For those who are unfamiliar with self-directed IRAs, they are IRA accounts that let you invest your retirement funds into a wide range of alternative investments: from real estate to tax liens to cattle breeding ranches. There are only a few restrictions: namely that you can’t invest in collectibles or life insurance, and you and some members of your immediate family can’t personally receive benefits from your IRA investments. For the complete list of rules and regulations, talk with a custodian, self-directed IRA facilitator or an attorney familiar with IRA regulations.

Through a self-directed IRA or real estate IRA, one can invest in almost any type of real estate, domestic or foreign. In my personal experience, the only issue that I have ever faced was with foreign real estate, and the problem was with the country, not the real estate IRA. The country in which we were investing had never seen nor heard of a real estate IRA, and properly registering the title became a long and grueling process. To be fair, this was a developing country with a very unsophisticated and very manual property registration process. To date, it is the only country where I have encountered this difficulty, but if you use a real estate IRA to buy property in any developing country, then I would plan for delays.

Real Estate IRA: Which type should I get?

There are two types of real estate IRAs. The first is the traditional one, which is done through a self-directed IRA custodian. The biggest self-directed IRA custodian is Equity Trust. Setting up your real estate IRA in this manner will have the smallest upfront fees, but will include on going fees tied to the value of your IRA account. These can add up over time, especially if you have a large account. Keep in mind that there are also some time sensitive investments that may be difficult to invest in because of the approval process with the custodian. This is typically the best real estate IRA type for those who have less than $50,000, and who can spare the extra time.

The second type of real estate IRA is the checkbook control real estate IRA. As the name suggests, a checkbook control account has its own checking account and checkbook. The holder is designated as the representative and can issue checks at will. This does not, however, release the holder from the rules governing IRAs, and with more freedom comes more responsibility. In the other model, if you attempt to enter a prohibited transaction, your IRA custodian will likely stop you. In the checkbook control model, account holders must use their own discretion, and the penalties are severe if one enters into a prohibited transaction. There are several self-directed IRA facilitators who can create the accounts, the largest of which is Guidant Financial Group. The main benefit of the checkbook account is that you can react quickly to investment opportunities, and you can avoid a lot of hassle and additional paperwork. Most real estate investors know that the best opportunities don’t last long, so being able to react quickly is vital to success. This route is not cheap on the front end, but it has fewer ongoing fees, and the fees are not tied to account size. This can be a good option for investors with more than $50,000 or that are dealing with time sensitive investments.

Zimbabwe’s Inflation Tops 100,000 Percent

As the U.S. battles a serious inflation problem, we can at least be thankful it’s not as bad as the inflation issues Zimbabwe faces. Yesterday, Zimbabwe’s statistical office reported inflation of over 100,000 percent. That’s right, 100,000 percent; no extra zeros have been added for emphasis.

To give you an idea of what that type of inflation looks like, in Zimbabwe a simple loaf of bread costs around Z$3.5 million, according to VOA News. Can you imagine having to carry around 3.5 million dollars in cash just to buy a loaf of bread? As you have probably realized, this is not good for Zimbabwe’s economy; things have become truly disastrous there. Zimbabwe’s per capita GDP has shrunk from $200 in 1996 to around $9 now, according to CNN.

Unfortunately, a country that was on the rise has essentially been ruined by one man: Mr. Robert Mugabe. Since he won’t allow anyone to run against him in the elections, it doesn’t seem like he will be voted out anytime soon. The good news is that he is 84 years old, so he can’t last all that much longer. Castro resigned this week, so maybe Mugabe is the next dictator on his way out. Here’s hoping, anyway.

With the U.S. inflation rate at a little over 4 percent we don’t need to worry about problems of this scale, and I’m very thankful for that. But inflation in the U.S. is still a major problem. If people continue to overlook inflation, it will eventually eat their savings. Plan for inflation now, and invest accordingly. Ignore it, and your retirement could be in peril.