We looked at the most important aspects that are considered when determining our credit score.  Today, we will look at some of the government’s efforts to reform some of the corrupt practices that the credit card industry has used against borrowers.

     It is important to understand the changes happening in the credit card industry.  Even borrowers with great credit have found themselves negatively impacted.

     For example, millions of consumers were hit with reduced credit limits on their credit cards.  These reductions came even if the consumers were not considered “risky.”  As a result of the reduced credit limits, consumers ended up with higher debt ratios and many consumers’ credit scores dropped.

     In May of 2009, President Obama signed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act. 

     Here is a summary of some of the main changes expected in the credit card industry.

Notice requirements

     Creditors are required to give 45 days’ notice regarding any significant changes to the terms of a credit card agreement.  Previously, only 15 days’ notice was necessary.

     If borrowers do not agree with upcoming changes, they have a right to cancel the account.  The creditor can increase the minimum monthly payment, but they cannot require the balance to be paid in full.

     Creditors are also required to provide statements at least 21 days before the payment due date.  This is one week longer than what was previously expected.

     Disclosures of credit card agreements must also be improved.  This includes posting the agreement on the creditor’s website.

Interest rates and fees

     Interest rates cannot be raised on existing balances for one year after the account is opened.  After that, the new, higher rate is limited to new transactions.  Teaser rates must be fixed for at least six months.

     Some borrowers have multiple interest rates being applied to different portions of their credit card account.  When borrowers pay more than the minimum payment, the additional funds must be applied to the highest interest rate’s balance.

     Creditors are no longer able to charge a fee for borrowers going over the credit limit.

Protecting younger consumers

     In an effort to better protect young and impressionable college students, borrowers under 21 cannot obtain credit cards on their own.  Younger borrowers will need to submit a written application with the signature of a co-signer over the age of 21.

     Ideally, this new provision will reduce the number of college students who graduate with huge credit cards bills racked up over the four year college experience.  It will enable these students to graduate in a better financial position so that more of their paychecks can go to saving and investing than to debt reduction.

     The changes outlined in the CARD Act will help protect consumers against unethical practices.  However, these changes alone are not enough.  Borrowers must become more informed credit card users to better guard against falling victim to their creditors.

     Since the meltdown of the financial industry, the ability to borrow money has become more and more difficult.  The days of obtaining large loans with no proof of income are gone.  In fact, retirees often find it challenging to refinance a mortgage based solely on their retirement income.

     Solid credit scores are much more important when trying to obtain a loan for any reason.  A better credit score will not only improve the chances of obtaining a loan, but also allow for better interest rates on the funds borrowed.

     Today, we will look briefly at some of the most important aspects that are considered when determining our credit score.

Payment history

     Being on time is a critical component in maintaining a good credit score.  Lenders want to know that their borrowers are reliable and punctual.

     While one late payment won’t harm a credit report terribly, a pattern of tardiness most definitely will.  Life happens.  We should not let one late payment discourage us.  Over time, the score will come back up as long as payments are regularly on time.

Total debt owed

     A high percentage of debt will cause a lender to shy away from a potential borrower.  If a borrower tends to use the majority of his or her available credit, they appear to be spending much more than their current income can afford.  That is not a good sign.

     It is best to keep the usage of all credit accounts at or below 40%.  If the usage amount is higher, we should work on paying them down as quickly as is possible.

Length of history

     The longer the time since a borrower first established credit, the better.  A long credit history gives a creditor a better idea of a borrower’s ability to pay.

     Even if we don’t use our older credit accounts often, it is a good idea to keep them open and to use them to reflect some activity on the accounts.

New accounts

     Opening new credit accounts can hurt a credit score.  A creditor does not want to feel that they have to compete with too many other creditors for a borrower’s discretionary dollars.

     We should avoid opening too many new accounts.  Also, we should be careful about closing too many of the accounts that we currently have open.  Closing accounts can affect the credit score as well.

Types of accounts

     There are two main types of accounts – installment accounts and revolving accounts.

     Installment accounts are loans that last for a given amount of time, such as a mortgage or a car loan.  Once principal is paid, it cannot be re-borrowed.  The account is closed when the balance is paid off.

     Revolving accounts are loans that don’t have a specific expiration date, such as a credit card.  The amount borrowed can be continually paid off and re-borrowed.  The account is not automatically closed when there is no balance due.

Monitoring our credit reports

     It is important to check our credit reports on a regular basis.  Once a year should help ensure that nothing unusual is happening with the accounts.  It encourages us to observe our spending habits and identify ways to improve our credit and our score.

     As retirement nears, there is more to think about than just which custodian we will use to roll over our retirement account once we leave our employer.  Our retirement nest egg must not only supplement Social Security and any other streams of income we may have available, but it must also last the duration of our retirement years.

Retirement lasts a long time

     Retirement has changed over the years.  A period of life that used to be brief, retirement now lasts about 30 years for many people.  The retirement period is almost as long as the time spent working.

     With that in mind, planning an income stream in retirement requires careful consideration.  It is not as simple as moving the funds out of the employer’s account and into a bank savings account or CD.  Inflation will quickly erode the spending power of the nest egg.

     While we don’t want to be overly aggressive in investing our retirement nest egg, we still should use a somewhat conservative combination of investments to help the income stream last the course.

Income streams for different needs

     During our retirement period, we find that our cash flow needs change.  Usually the earlier years in retirement require larger cash flow.  There may still be a mortgage and/or car payment.  Travel and vacations are usually more frequent as well.

     Once the mortgage is paid off, expenses may decrease.  However, there is still the possibility of additional health care expenses in the later years.

Income streams for different time periods

     Another consideration when planning retirement income is the market volatility.  If all funds are invested with the same asset allocation, a terrible market, like 2008, can greatly impact a retiree’s ability to fully fund all of their retirement years.

     With that in mind, funds should be separated so that monies being used in the near future are invested less aggressively, and more securely, than cash that will be needed 10 or more years from now.

Multiple options for current needs

     Current cash flow needs can be funded in a variety of ways.  Options include, but are not limited to, CDs, mutual funds that invest in dividend-paying stocks, bond mutual funds, and single premium annuities.

     CDs are currently not paying high interest rates, but it may be possible to get better returns than a regular bank savings account without taking on much additional risk.  While it may not be the best choice for a large portion of retirement funds, it can work for a small portion.

     Mutual funds that invest in either dividend-paying stocks or bonds will provide larger gains and higher interest rates than what is presently available with a CD.  Since returns will fluctuate, this option should also be used for a portion of the portfolio.

     Lastly, annuities are a great vehicle for creating a guaranteed income stream.  There are many ways to set it up, depending upon the retiree’s goals.  While they are great for short term, investors should be careful about tying too much up in one investment.

     A financial professional can help a retiree create a long term action plan for their retirement income needs.  Remember that there is a difference between a registered representative and an investment advisor.  If we choose to seek out the assistance of a financial professional, we should find one who is able to offer financial planning and investment advice.

     With all of the financial troubles and retirement account mistakes that have plagued investors in this country lately, the investment industry has been debating the regulations and standards expected of financial professionals.

     One major area of disagreement comes with respect to whether the standards expected of financial professionals should be identical.  As it stands now, there are different expectations for brokers and advisors.

History of the standards

     In the 1940s, laws were established for the brokerage industry.  Brokers are, in essence, the middlemen between investors and registered investments.  They initiate transactions, buying and selling investments for profit.  While some transactions are done on behalf of a client, brokers will also buy and sell securities for themselves.

     The standard established for brokers was an obligation to ensure that the investment is “suitable” for the client.  There is no requirement to take care of the client, such as recommending a product that is truly in the best interest of the client.  In fact, a broker is not required to gather adequate background on a client in order to ensure that the products provided really meet the needs of the client.

     During the same time period, the Investment Advisors Act of 1940 was passed to establish a standard for those who provide investment advice.  Contrary to the standard required of a broker, an advisor must gather details about the client and provide recommendations that are in the best interest of the client.  There is a fiduciary obligation taken on by an investment advisor, and there is a heavier amount of responsibility expected of the advisor.

     Sadly, the differences between the two roles have been glossed over, and most investor clients are unaware of the differences.

Registered representatives

     Registered representatives are employees of broker-dealer firms.  For example, wirehouse firms are broker-dealers.  As employees of broker-dealers, registered representatives are expected to honor the suitability standard when assisting their clients in choosing investment options.

     Registered representatives, as employees, have a duty to their employer to help the company make a profit.  While most registered representatives will make an effort to present sound options, the client is not the first priority.

     Another fact often unknown by investor clients is that registered representatives are not able to provide investment advice.  With liability concerns, the broker dealer employer will often not support this activity by their registered representative employees.  This is really interesting when we consider that so many of them call themselves financial advisors.

     Some broker-dealers will also register as investment advisors.  Some registered representatives are then able to be investment advisor representatives.  However, many financial professionals who call themselves advisors have not taken this extra step.

Investment advisors

     The fiduciary standard expected of an investment advisor requires an advisor to put the client’s interest above his or her own interest.  It requires a truly unbiased recommendation.

     As such, investment advisors provide fee-based advice.  Since they are compensated the same regardless of the advice given, a client can be more confident that the recommendations are really in their best interest.

     Investment advisors must get to know their clients as completely as possible to make sure that the advice provided best meets the client’s needs.

     While broker-dealers are less open with respect to their compensation arrangements, investment advisors must disclose this, along with any potential conflicts of interest.  This enables clients the opportunity to determine their level of comfort with following through with the advice given.

     Investor clients are welcome to choose to work with either registered representatives or investment advisors.  There is nothing inherently wrong with either choice.  However, it is most important to understand the role that the financial professional has agreed to take in working with you so that you can feel comfortable with the actions you take as a result.

     Recent surveys have shown that most employees do not understand how their employer-sponsored retirement accounts work.  In an age where pensions are less common and Social Security is on the verge of disappearing, employees have been forced to become more responsible for their comfort in retirement.

     However, employees have not been apt to embrace this new responsibility.  Today, we will look at three of the most common mistakes employees are making with their retirement accounts.

Lack of participation

     The economic instability of the last couple of years has changed America’s habits when it comes to the use of earned income.  One of the worst effects has been in how employees contribute to retirement accounts.

     One sad statistic that I read about is the fact that about half of employees are not taking advantage of their employer-sponsored retirement account.  While it is better to have a retirement plan where our employer is contributing to the account on our behalf, not having a match should not be a reason not to contribute ourselves.

     Any contributions we make to our retirement account not only reduce our current taxable income, but also get us closer to having a sizable retirement nest egg to help us live comfortably in retirement.

     We cannot let market volatility convince us that it is unwise to contribute to the plan.  We should contribute as much as our budgets will comfortably allow.

Cashing out upon termination

     When an employee leaves a job, whether the reason is a career change, a layoff, or retirement, that employee is free to take the retirement account assets.  The challenge, however, is the method used.

     More than half of employees cash out the retirement account when leaving a former employer.  They look at the funds as “free money,” in a sense.  Unfortunately, that choice costs more than most people realize.

     Cashing out a retirement account before age 59 ½ triggers a double-taxable event.  Since those funds were invested pre-tax, they are taxable upon distribution.  The funds are taxed as ordinary income.

     The second tax is a penalty for being under the age 59 ½.  The government provides the tax deferred benefit as a way to encourage saving for retirement.  If the funds are used before retirement, an additional 10% penalty is assessed.  Some employees find that they lose close to half of their account value when they choose to cash out.  Not only have they set themselves back in saving for retirement, but they have also lost a large portion of their own contributions, which came out of their paychecks.

Taking loans

     Many employees look at the ability to take loans from their retirement account as a bonus.  I argue the opposite.

     Granted, the interest rates charged on these loans are lower than on credit cards and other unsecured loan options.  It can also be considered a plus that the interest is paid back to the retirement account.  However, there is also an opportunity cost involved.

     Opportunity cost refers to the cost of not having access to another option.  For example, an employee may be paying back a 5% annual return on the funds borrowed, but they may be missing out on a year where their portfolio could have earned an 8% or 10% return.

     There is also a concern about the employee’s ability to pay back the loan.  If financial concerns forced the decision to take the loan in the first place, what happens if the employee is unable to keep up with the payments?

     A lack of timely payments may cause an employer to issue a Form 1099 at the end of the year.  That changes the characterization of the loan to a distribution.  As a result, the withdrawal is now taxable as ordinary income.  If the employee is under age 59 ½, the 10% penalty will also apply.

     I have attempted to address a few of the most common retirement account mistakes that I have seen in working with employees over the years.  The best way to reduce our exposure to these mistakes is to increase our understanding of our retirement accounts.  We can seek information from our employer, the plan custodian, or the plan’s advisor.  Fully understanding the consequences of our actions can enable us to prepare better for a great retirement.