A new Congress, a rate cut and you:
Interest rates fell to historic lows this week. Republicans won the House and Senate, giving the White House new ammunition for its economic agenda.
In today's Managing Your Money, we look at what these changes will mean for your personal finances.
(Reported by USA TODAY's Julie Appleby, Sandra Block, Christine Dugas, Earle Eldridge and Thomas A. Fogarty.)
THE NEW CONGRESS:
Retirement
What kind of 401(k) reforms will get through the Republican-controlled Congress? Since the Enron scandal, Congress considered numerous proposals to reform 401(k) plans. But with Republicans in charge, modest changes are expected. Look for bills that would:
Make it easier for employers to offer investment advice to workers. Financial firms that manage 401(k) plans would be permitted to provide the advice, as long as they disclose potential conflicts of interest.
Allow workers to sell company stock three years after receiving the shares in their 401(k) plans. Now, many companies restrict when workers can sell. Proposals to limit the amount of company stock employees can own in their 401(k) plans have little chance of passage, says James Klein, president of the American Benefits Council.
Increase the amount workers can contribute each year to 401(k) plans. The current limit of $11,000 ($12,000 for workers 50 and older) is scheduled to increase to $15,000 by 2006. Congress may accelerate the schedule, allowing workers to increase contributions sooner, Klein says.
What changes are in the works for individual retirement accounts? Lawmakers may also accelerate increases in investment limits for IRAs, Klein says. The current limit of $3,000 a year — $3,500 for those 50 and up — is scheduled to rise to $5,000 by 2008.
Upcoming retirement legislation may also loosen restrictions on mandatory withdrawals from retirement plans, says David Wray, president of the Profit Sharing/401(k) Council of America. Now, IRA holders must start taking minimum withdrawals after they turn 701/2, even if they don't need the money.
What about Social Security? Congress will probably debate how to shore up Social Security, but big changes are unlikely. During the campaign, few Republicans spoke out in favor of proposals to invest Social Security contributions in the stock market, says Chris Hansen at the AARP. "Given the investment climate right now, there are more people running away from that idea rather than toward it," he says.
Taxes
Can I count on a tax cut? President Bush on Thursday promised to seek congressional action early in 2003 on "new growth and jobs packages" to strengthen the economy. That means tax cuts.
Tom Ochsenschlager, partner at accounting firm Grant Thornton, says tax-slashing fervor may be moderated by a growing federal deficit and Senate rules that give strong influence to a minority of members.
Which taxes would they most likely cut? Bush offered no specifics. Greg Valliere, chief strategist at the Charles Schwab Washington Research Group, expects a tax-cut package that could find bipartisan support — possibly payroll tax reductions for wage earners matched with cuts in taxes paid by investors.
What might investors look for specifically? Republicans this year revived the possibility of increasing the amount of capital losses investors can use each year to offset ordinary income. It's been limited to $3,000 a year since the 1970s. There's been talk of doubling or tripling it.
What else? Dividends are now subject to tax at both the corporate and individual level. Republicans have talked about eliminating the double taxation. A possible compromise, says Valliere, would be to start taxing investors' dividends like capital gains. Dividends are now treated as ordinary income, which carries higher tax rates.
What about the 10-year tax cut enacted in June 2001? Isn't that temporary? Yes. Under terms of the act, it would be repealed after a decade. At some point Congress will move to make it permanent. Such a vote would repeal permanently the federal estate tax.
Health care
What will happen with Medicare? Look for proposals to add a Medicare drug benefit that relies on the private sector, rather than a government-run program. The federal budget deficit will limit the amount of money that can be spent to provide the benefit, so some analysts say the winning proposal may offer it only to low-income seniors. Overall Medicare reform proposals could include a market-based approach that would give enrollees a set amount of money toward coverage, then require them to choose among competing private insurance plans with differing prices and benefits.
What about a patient's bill of rights? The Republicans may resurrect their plan to offer a scaled-down version of the bill aimed at protecting patients from some excesses of managed care, but it will probably not include a right-to-sue provision.
Will tax credits be offered to help people buy health insurance? The Republican majority will look to tax credits for a host of health care ills, including helping the uninsured buy health care. Because of budget deficits, the amount of the tax credit may be limited. Congress may also support a Bush administration proposal to allow employees to roll over year to year part of pretax money set aside in flexible spending accounts to use for health care.
What else will happen in health care? Look for lots of talk about high medical malpractice premiums and efforts to lower them by limiting jury awards. Such measures are supported by doctors, hospitals and business leaders, but opposed strongly by patient advocates and trial lawyers.
Bankruptcy
Will Congress tighten the bankruptcy law? The new balance of power in Congress makes it more likely that a sweeping bankruptcy reform bill finally will win approval. But it may not happen until next year.
The bill, which would make it harder for many families to wipe out debts in bankruptcy, has received strong support from the credit card industry and opposition from consumer advocates.
A compromise version of the bill was worked out by a congressional committee earlier this year, but passage was held up by a controversial provision that would prevent anti-abortion activists from escaping legal judgments by declaring bankruptcy.
Any move to pass the bill before the end of the year would involve alienating pro-life groups. Opponents of the bill might use stalling tactics, making it impossible to pass in the short time left.
Next year, with the Republicans in control of the House and Senate, it will be easier to start fresh, without the abortion provision, says Sam Gerdano, executive director of the American Bankruptcy Institute. Republicans won't have to make as many compromises to get the bill passed.
THE FED'S RATE CUT:
Credit cards
Will card issuers pass along the rate cut? Credit-card holders are likely to get no relief from the Fed's half-point rate cut. That's because many credit cards set minimum rates, which already have been reached.
Credit-card rates are higher than they were a year ago. Penalty rates — which kick in when you pay your bill late or go over the borrowing limit — have helped push the average bank card rate to 14.74% from 14.48% a year ago, according to CardWeb.com. Card rates could even rise in January, when issuers traditionally adjust pricing. Late payments are growing, and the amount of uncollectable card debt is high at about 6%, says Robert McKinley, CEO of CardWeb. Credit-card issuers always pass along those added costs through higher rates, he says.
What can I do? One way to get out from under high-rate card debt is to take advantage of much lower rates on home-equity loans, if possible. Use the money from a home-equity loan to pay off your card debt and avoid running up new card debt.
Auto loans
Will the rate cut mean more zero-percent financing and cash-rebate deals from automakers? Most certainly. DaimlerChrysler Services, the finance arm of DaimlerChrysler, sent a memo Thursday to its Dodge, Chrysler and Jeep dealers on the East Coast, telling them it was lowering by a point and a half the annual interest rate it would charge dealers whose auto buyers borrow through DaimlerChrysler. Dealers usually raise the rate by a quarter- to half-percentage point to earn profits.
Chrysler officials say the rate cut was not linked to the Fed action. But the Fed move means cheap financing deals are less costly to automakers. That could allow them to expand terms of the loans — say, zero-percent financing for up to six years. About one of four loans now are zero-percent deals. Most dealers now have too many new cars sitting on their lots, making it more likely they'll expand loan deals.
"We expect incentives to be enhanced over the next several weeks by the Big Three and others," says Paul Taylor, chief economist for the National Automobile Dealers Association. "GM has already sweetened some incentives."
Will it be easier to get a new car loan if credit is not spotless? Possibly. During slow sales periods, automakers sometimes use their financing units to relax credit-score requirements so that more buyers can get a new car loan. Some dealers say a surprising number of customers with questionable credit histories are being approved for loans by the automakers.
Savings rates
Will the rate cut penalize savers? Consumers seeking a safe, liquid place to park their money are in a no-win situation. The Fed's latest rate cut will soon push yields on most money market mutual funds and short-term bank certificates of deposit below inflation, which is running at 1.5% annually.
This week, one-year CDs average 1.68% and six-month CDs average 1.50%, according to Bankrate.com. Those yields don't reflect the Fed's rate cut.
FDIC-insured money market accounts are already below inflation — yielding on average 0.95%. They could go down to 0.75%, says Greg McBride, a financial analyst at Bankrate.com.
The average money market mutual fund yields 1.21%, which will drop in coming weeks to about 0.75%, says Peter Crane, editor of iMoneyNet's Money Fund Report. Crane expects many money funds to waive expenses so that they don't fall below $1 a share.
Rates vary, so it pays to shop around. Otherwise, the only way to get a higher return is to sacrifice safety or liquidity, Crane says.
Should I put my money in a long-term CD? It doesn't pay to lock up money in long-term CDs. Ideally, consumers should spread their money among CDs with maturities of a year or less, so that as rates eventually begin to climb they're in a position to capitalize on rising yields, McBride says.
Bond yields
Will all bond yields go down? Fed rate changes primarily affect short-term bonds. Anticipating a move by the Federal Reserve, the bond market already had factored in the latest rate cut. Still, most bond experts had expected a smaller reduction. So yields on short-term Treasury securities have fallen since the announcement, says Robert Auwaerter, bond manager at Vanguard Group.
Are bond mutual funds still a good investment? The Fed signaled that this would be its only cut this year. Interest rates are at 41-year lows. That could mean the bond market is near its peak. So investors should think twice about pouring money into bond funds because they could be setting themselves up for a fall. When interest rates rise, bond prices fall.
No one is predicting a rate increase soon. "Unless we see unequivocal evidence of economic recovery, rates could stay low for a while," Auwaerter says.
Mortgages
What does the Fed interest rate cut mean for mortgage borrowers? Very little for those taking out 15- or 30-year fixed-rate mortgages. Dan Gilbert, chairman of Quicken Loans, says fixed-rate mortgages, which have been hovering at near 6% for months, are already close to their "natural floor." But he says it could help keep rates on those loans from rising.
Adjustable-rate mortgages are a different story. The Fed action has its greatest impact on short-term borrowing, and that's what determines interest rates on ARMs. Frank Nothaft, economist at mortgage investor Freddie Mac, says this week's average interest rate of 4.15% for a 1-year ARM roughly matches the lowest rate in 18 years of tracking by the firm.
Because the Fed cut deeper than expected — a half point rather than a quarter point — Nothaft says the ARM rate is likely to go lower. The benefit will go to new borrowers and those facing an adjustment in their existing ARM.
Home-equity lines of credit may also be cheaper because rates vary according to the prime rate, the benchmark for many consumer loans. Banks reacted to the Fed move by cutting the prime rate by a half point to 4.25%.
In a survey completed before the Fed cut, Bankrate.com said the average home-equity line of credit carried a 5.26% interest rate. Look for that to drop. But Bankrate.com's Greg McBride says many home-equity lines, like credit cards, carry minimum interest rates that would block the potential benefits of the Fed action. |
