Don't exhale just yet.
The recession is winding down, and shell-shocked consumers can finally begin to repair finances thrashed by the housing bust, stock-market collapse, and wretched job market. But the white-knuckle ride may continue, even as the economy recovers. The whole nation has been living on borrowed money and putting off tough decisions, and the bills are finally getting too big to ignore. Here are six eventualities that will keep the pressure on American families—while providing even more reason to save extravagantly and live carefully:
Taxes will go up. Politicians don't want to talk about it, but there's almost no way around the fact that middle-class Americans will have to pay more out of their pocket to keep government functioning. In many states this is already happening. At least 40 states face gaping budget shortfalls this year, with several of them planning to plug the holes by raising income or sales taxes or enacting new taxes on things like services. At the federal level, some taxes are already going up on high earners, but that won't be nearly enough to cover the gap between what Washington spends and what it takes in every year. "It's inevitable that they'll have to find a way to have a truly middle-income tax increase," says Clint Stretch of Deloitte Tax. That creates a conundrum for President Obama, who has backed himself into a corner by pledging no new taxes on the middle class. That promise seems impossible to keep with the government's debt approaching $14 trillion—a sum equal to the nation's entire economic output—and Greece providing an alarming example of what happens when fiscal discipline erodes.
It seems likely that Obama will use the final report from his debt-reduction commission, due December 1 (after the November elections, naturally), as a starting point for a debate on how to get the debt under control. The partisan warfare that follows will make healthcare reform look like a kindergarten sing-along. A new value-added tax on goods and services is one option, with Washington lowering or simplifying income taxes to make it look like a net win for the middle class. Paycheck withholdings for Social Security and Medicare could go up. Long-standing deductions or exemptions for mortgage interest, health benefits, and other privileges could be reduced or eliminated over time. The bite on taxpayers won't necessarily be severe, but the rancor that comes with it will make everybody feel lousy. A good bet is that Congress dickers for at least two years, with no major changes coming until after the 2012 presidential elections.
How to prepare: Ask your accountant or financial advisor about the tax implications of any big financial decisions—and plan conservatively.
Government services will go down. Like tax increases, this is already happening at the state and local level, and it will trickle up to the federal government soon. The low-hanging fruit is stuff that state and local governments spend the most on: education, Medicaid, and other services for the poor, and public services like the fire and police departments. Several states, like New Jersey, Missouri, and Nebraska, are considering ways to consolidate town and county governments, to provide services with less overhead. The biggest battle at the federal level will be over cutbacks in Medicare and Social Security payments, which account for 35 percent of all federal spending. In addition to that, the postal service will reduce hours and service, and other agencies will follow. There will be fewer government jobs, as federal agencies downsize. And stimulus checks will become a thing of the past—so if you got one over the last couple of years, frame the stub.
How to prepare: If you rely on any type of government service, do contingency planning and make backup plans in case it disappears.
The retirement age will go up. The official retirement age—the point at which you can claim full Social Security benefits—is rising gradually from 65 to 67 by the year 2027. Expect it to go higher, sooner. Social Security is on a path toward insolvency at current payout rates, and one obvious way to fix that is to delay the point at which payouts start. Corporations, local governments, and many other institutions peg their own retirement ages to the Social Security standard, so many folks could end up working longer. A lot of them need to: The majority of Americans lack enough savings to retire, even with full Social Security payments. A few extra years of work might sound like a bummer, but expanding your planned working life also gives you a bit of breathing room to accomplish goals and build a nest egg.
How to prepare: Do your retirement planning under a variety of scenarios, including different retirement ages. Think about part-time work you might do to supplement Social Security payments. And build the biggest nest egg possible.
[See the 10 Cities for Retirement Property Steals.]
Incomes will rise slowly. That's partly because taxes will take a bigger bite out of your paycheck, but also because the job market is likely to stay weak for an uncomfortably long time. The Congressional Budget Office, for example, predicts a higher-than-average unemployment rate through 2015, and with an excess supply of workers, employers will be able to pay less. We're also in the midst of long period of transition in which big U.S. companies are substituting technology or cheap foreign labor for American workers, further depressing hiring and incomes. The key to getting raises and promotions will be making yourself more valuable—by getting extra training or education, say, or solving problems that stump others.
How to prepare: Start by living within your means and paying down any debt you have. And never take a future raise for granted. It might also be prudent to find a second stream of income, from a small Web business or consulting jobs, for example.
Uncertainty is here to stay. The recession is over, but it's not back to business as usual. The U.S. economy is fundamentally changing, as foreign competition gets tougher, technology revamps the way companies operate, and old skills become obsolete quickly. There will still be good opportunities for workers who are able to adapt, but those expecting a paycheck for simply showing up every day and doing the same old thing will be the first to go when things change. "Be flexible and work outside your protected comfort zone," says Susan Goldberg, a New York executive search consultant. "The individuals willing to take risks and operate differently will succeed."
How to prepare: Ask what could go wrong with your job, income, and finances. Anticipate changes instead of simply waiting for them to happen. Identify your vulnerabilities and address them, whether that means getting more education, changing careers, or downsizing your lifestyle so you can save more.
Big institutions won't take care of you. Maybe you'll luck out and get all the support you need from your company, for your entire career. But don't count on it. One lesson from the last several years is that the era of stable employment and predictable careers is over, with agility and innovation being the new requirements for survival. "It's important for companies today to be extremely flexible," says Dan Amos, CEO of insurer Aflac. "They've got to be able to turn on a dime." That's true for workers as well, and if you're counting on somebody else for job security, perks or benefits, or retirement income, you'll be vulnerable when the next wave of transformation hits. Or the one after that.
How to prepare: Enjoy big-company benefits if you've got them, but don't assume they'll last forever. Exercise your entrepreneurial muscles, even if you work for somebody else, by coming up with new ways to solve problems and get the job done more efficiently. Be as self-sufficient as possible, and if you've been doing the same thing for a long time, ask yourself if it's time to do something more innovative or exciting. You'll be happy you did.