Tough financial choices

| August 04, 2009

Buy or lease?
Few owner-operators lease a truck. All things being equal over enough years, buying leaves you with more in your pocket.

A new truck is a three-year depreciable asset; the most common depreciation schedule yields deductions overlapping four calendar years. So for a five-year loan, the trick is planning to cover cash flow in the fifth year, after the tax deduction has ended.

On the other side of the buy-lease debate, five-year TRAC (terminal rental adjustment clause) leases, which have a buyout at the end, have their proponents. Many carriers, for instance, structure leases to favor novice owner-operators with little to no truck-buying history or cash for a down payment.

“We’re not seeing a lot of folks who have that kind of money and can afford a big down payment,” says Steve Crear, Schneider Financial’s general manager.

Another advantage of leasing is that “you’re generally not as committed to the length of the contract,” says Mark Miller, tax manager for ATBS, the nation’s largest owner-operator financial services provider. That means it’s easier to get out of the lease or renegotiate into a newer truck to keep maintenance expenses low.

“We like to see the deal structured in order that before the five-year end they could trade,” says Crear. “That’s an ideal guideline — 42 months, 48 months to trade.” The goal is to keep truck maintenance down and tax management simple. That way, a new owner-operator can focus on building his or her business.

Unlike a purchase loan, where scheduled depreciation determines your tax deduction, under a lease your tax deduction is equal to your lease payment, typically $2,000 to $2,500 for a new truck at Schneider, Crear says. “You deduct everything just as it’s paid.”

Compared to buying, leasing generally costs you more, but saves more in taxes. In some programs, like Schneider’s, you can reduce your monthly lease payments to reflect your tax savings, a tax management tool Crear says is invaluable to new owner-operators.

On the other hand, claiming depreciation on a new truck gives you the flexibility to structure the rate to match your tax deductions. But Miller warns against spending money “just to take advantage of the tax deductions. If you need tax deductions, we’ll raise our fees,” he jokes. Rather, “Let your business dictate your tax decisions.”

With today’s tight credit and rising new truck prices, an in-frame overhaul to keep a rig running might be more popular than ever. Still, for a borrower with excellent credit and solid buying history, trading the old truck is often the best choice, as this example shows.

The example assumes an interest rate of 7.5 percent on the new truck loan, which is available today only to borrowers with better-than-average credit. As that percentage increases, the in-frame choice looks better.

A typical in-frame will consist of “replacing cylinder kits and heads, injectors, the turbo or turbos – the power-producing parts, really,” says Bill McClusky, ATBS maintenance management consultant. If done at a shop in the engine manufacturer’s network, warranties on an overhauled powertrain are available — and worthwhile for the price, says owner-operator Ken England. He purchased extended coverage for an overhauled Caterpillar C12 for five years at less than $2,000, and the warranty saved him around $5,000 in repairs and towing charges.

One variable not accounted for in this example is the expected downtime associated with any older truck, overhauled or not – the “wild card,” as Schneider Financial’s Dan Kleiser, lease portfolio manager, calls it. “You count on needing the overhaul, but you don’t count on the nickel-and-diming that comes along with an older truck.”

Twelve cents or more per mile in maintenance savings is the industry’s operative figure for trucks of this age. Considering that, a new or late-model truck starts to look pretty good, especially after an older truck’s extended period in the shop – or a $1,000 tow bill.

This comparison doesn’t include financials beyond year three, when in this scenario the powertrain warranty runs out. In the fourth and fifth years, you’ll still be making payments of $2,000 a month. Maintenance costs for the in-frame and other needs go on, but you could continue to run that truck for several more years. “If the truck remains in good condition,” says Chris Brady of Commercial Motor Vehicle Consulting, the owner-operator “can run it for another year or four years – he’s reducing his cost of ownership. The longer you own the vehicle, the better ownership becomes.”

In today’s economy, with investment return rates low and short-term interest rates high, it’s usually better to pay off high-interest credit-card debt before considering any new savings or investments.

“You’re getting very low return on your cash today,” Brady says. “Money market returns are only 1 percent.” Because credit card debt is often at double-digit levels, paying it down produces a far better yield for your available cash.

The average credit card debt held by owner-operators today, according to the 2009 Overdrive Owner-Operator Market Behavior Report, is $12,363. For a transportation business, the report’s author Brady suggests, where “guys might be throwing fuel bills on it monthly, and purchasing equipment,” this amount could be better managed at lower levels. Focusing on any excess short-term debt in lieu of extra saving or investing is by far the best choice. “First get your cash in a good situation,” Brady says, before hunting out any decent investment opportunities.

This one is something of a no-brainer, with one important caveat: that you pay the credit card balance in full monthly. Benefits from credit card use extend beyond discounts on credit fuel purchases. Some cards offer cash back on every purchase, credits for airline or other travel use, or other givebacks.

For instance, the average FleetOne fuel card, the company claims, will save you $400 a year on fuel at 20,000 gallons purchased via rebates granted in $15 increments. Add the $1,400 you’ve saved by getting the cash diesel price with the card, and that’s a total savings of $1,800 a year.

By comparison, consider the same amount of fuel purchased with the business/consumer Miles by Discover card, which offers credits for all purchases to be put toward travel expenses.

At $2.35 a gallon for diesel, the national average June 1, the $47,000 in fuel purchases would net you 47,000 miles at the base rate of a mile per dollar in purchases. With each 10,000 miles worth $100 in travel purchases, your fuel purchases alone would net you $470 in yearly travel benefits. Discover’s Miles and certain other cards also offer double-mile promotions, so annual benefits could be even higher.

Some users prefer straight cash-back programs because the benefit is not limited to travel or gifts.

You have a choice whether to begin receiving Social Security benefits early (age 62) or at full retirement age (at 66 if you were born between 1943 and 1959, at 67 if 1960 and later). Say you’re 62 and, like the average owner-operator, with a working income of $51,000 averaged over enough years to qualify, you would be eligible for $1,050 a month now or $1,393 a month in 2013, at age 66.

As illustrated in the graph, if you start now, by the time you turn 66, you’ll have collected $50,400 in benefits. If you start at 66, you’ll need to live through age 78 and a half to make up for those missed benefits; beyond that, the higher payments would be to your advantage. (SS payments are taxable at varying levels depending on your income, which can skew these calculations a bit; if you want to do this precisely for your situation, take it into consideration and get with your accountant. Or visit ssa.gov/planners for some good calculators.)

Also consider that $50,400 taken in early Social Security could be placed in your Individual Retirement Account to gain interest. Assuming a modest 5 percent rate of return, over four years that amounts to $10,862 in potential income missed by taking Social Security benefits at full retirement age. But that only moves the “break-even” point between early and full retirement out about two and a half years, to 81. That happens to be the average male life expectancy, according to the Social Security Administration. For women, it’s 84.

If you’re healthy and can continue working, it’s probably best to wait. “It isn’t a hard and fast rule,” says ATBS’ Miller. “It’s a personal value decision.” Balancing your needs with those of your spouse, as well as evaluating your life expectancy, will likewise figure into your decision.

In the January 2008 issue of Money magazine, Janice Revell noted the Boston College Center for Retirement Research’s finding that among some couples where the husband is the primary breadwinner, the best strategy “is for the wife to take Social Security at 62 and the husband to wait.” She added, “In this scenario, a wife would take her benefit at 62 and inherit her husband’s larger check later,” assuming he dies first.

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