The DRA's "Dirty Little Secrets"

Congress passed the “Deficit Reduction Act”, or DRA, recently. I think the title of the Act is inappropriate, in that it provides for a reduction in the rate of deficit increase, rather than an actual reduction of the deficit itself.

Imagine if you or I decided we’d put into place a plan to reduce the rate at which we increase our credit card balance each month, while never actually paying down the principal! Whatever happened to fiscal responsibility??

At the end of the day, this DRA promises to reduce the budget deficits by about $40 billion over the next several years, or about 2.5% of the $1.6 trillion of projected deficits during that time period.

Here Are The Dirty Little Secrets
I’ve Found (So Far)

A few Dirty Little Secrets were hidden within the DRA, two of which will have an impact on you if you are, or will be, paying for college costs by way of loans – and let’s face it just about everyone has at least some loans in their college payment plan.

The first Secret is that it will now be illegal to consolidate student loans while the student is still in school, which was a favorable option allowing students to lock in lower fixed rates. This may not seem like such a big deal until you hear about the second secret.


The second Secret in DRA 2006 is that, no matter what, you only have one opportunity, as a user of student loans, to consolidate them. In the past, there was a small loophole which allowed to you re-consolidate loans if you took out another student loan after the initial consolidation. Not any more.

So, who is the benefactor of these Dirty Little Secrets? Sallie Mae, the privatized holder of most student loans – because if favorable consolidations were openly available, Sallie Mae would have to compete with every financial institution out there for your loans. And we all know what happens when competition is allowed in the marketplace! Why, inefficiencies are wrung out, and the fittest survive! And Sallie Mae is not among the fittest.

Another change that we knew was coming is that the new rate for subsidized (Stafford) loans will be increasing from 4.7% to 6.8%, and PLUS loans will hop up to 8.5% from 6.1%.

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* Medicaid Provisions
One last item that caught my interest in the DRA is the changes to the Medicaid program. Primarily, this provision makes some of the “qualifying” or Medicaid planning options a little more difficult. The other item allows for an exclusion of some Long-Term Care policy proceeds when qualifying for Medicaid benefits.

Annuities - Good, Bad, or Otherwise?

For many folks, questions about annuities are a large part of your financial concerns. So, I thought I’d take the opportunity this month to address some of the basics of annuities, as well as the ways annuities are used and abused.

First the basics: Annuities are generally a product of insurance companies. There are two components to the contract – a rate of return, either fixed or variable; and a payout, which may be deferred to the future or immediate.

To define these terms a little better:
· Fixed rate: this kind of annuity invests in very conservative assets. The rate of return is guaranteed, and usually slightly higher than current CD or money market rates.
· Variable rate: this type of annuity has multiple “sub-accounts” (like mutual funds) to choose from, allowing for fluctuating returns. The point is that with these investments, presumably you will have a greater likelihood of positive results. Oftentimes, the opposite may occur.
· Deferred: In a deferred annuity, the payout begins at some point in the future, usually retirement.
· Immediate: With this type of annuity, a lump-sum of money is deposited, and the payout begins immediately. The payout then continues for a certain period of time, or for the life of the annuitant.

All annuities share certain common characteristics, including tax deferral on the funds until withdrawal, surrender charges if the contract isn’t held for a certain period of time, penalties from the IRS if the money is withdrawn prior to age 59 ½, and a death benefit if the annuitant dies prior to the payout. Oh, yes, and one other common item: expenses and charges – of as much as 4% or more – are charged to the account annually.

It is due to the high expenses associated with annuities that they are a favorite of insurance salesmen. After all, high expense equals high commission!

One place that an annuity might make sense is for the individual who has maxed out all of their other tax-deferral options, such as 401(k) and deferred compensation plans, as well as a Roth IRA. Even so, you need to look closely at the expenses and examine the true return you can expect, as well as your need for an insurance component in your portfolio, before diving into an annuity.

Another good circumstance for a fixed annuity is to provide a steady conservative component of your portfolio. These should be compared to bond funds for yield to see if there is a benefit, of course.

The good news is that there have recently been some alternatives developed in the annuity arena by low-cost providers like T. Rowe Price and Vanguard. These companies’ offerings should be considered if you’re thinking about an annuity.