February, 2010
by Dr. Thomas E. Bell, CMG Member, Michelson Awardee (Retired)
Tom received his Ph.D. in Management from UCLA many years ago, and was a consultant for about 25 years before he retired. He is a recipient of the A.A. Michelson award (in 1975), has served CMG as its Treasurer and its Secretary, and has repeatedly been on the CMG Board of Directors. He retired at the end of 2005.
About the Author
Dr. Thomas E. Bell
Finally, after all those years of fearing you'll never have enough assets to retire, you've reached your financial objective[i]; you've even figured out how to handle the Required Minimum Distribution[ii]. Now, you may assume, you'll be able to relax without further fears. My experience is not consistent with that happy scenario; I have continuing financial fears, as well as fears about health and other issues that increase with time.
The focus of this article in the retirement series is the things that will still be there to fear - probably forever. If you track them, you can do some mid-course corrections to avoid some problems later on. If you can't avoid them, then (at least) you may be able to recalibrate your plans to cope with them. The worst of these things are significant, unexpected discontinuities - surprisingly significant changes in the way things work (like the simultaneous decline in prices of both equity and debt securities). Nassim Taleb has popularized the term "Black Swan" to describe these events[iii]. In general, I (obviously) can't warn you about the unexpected issues, but I can alert you to the causes of my continuing fears.
The most significant retirement issue new to our generation is the dramatic change in demographics throughout the world[iv]. Over the next decade, a large portion of the population (both in the US and around the rest of the world) will reach retirement age. A smaller portion of the whole population will therefore be available to produce the goods and services to support both themselves and unproductive (retired) people. This will impact each of us.
If you feel overwhelmed by the personal problems that are already confronting you, you may want to delay reading this article until you're better able to cope.
Lifestyle Issue: Deteriorating Physical Health.
As we have grown older, both my wife and I have experienced an increasing array of physical ailments. These have included spinal problems, cancer, degraded eyesight, and the need for more sleep. We have been pretty much able to cope with these, but I worry about whether my wife's cancers (now in remission) may return, and whether her ailments may make her life more difficult.
The future of her physical health concerns me enough that I insist she seek a physician's help when I detect something worrisome. Unfortunately, she often resists going to him. Fortunately, both of us need to take medications that require prescriptions from our primary-care physician about every 3 months (due to the need to monitor their effects), so I get my way - even if it's after a delay.
We need to track our medications and remember to take them - every time. This is a relatively new issue for us, and it makes me thankful that I was able to retire at age 65 (four years ago) so I don't need to remember them while on trips.
It's not much fun encountering the illnesses of old age, but it beats the alternative of dying and not being able to enjoy the endeavors of our off-spring. Because I expected the physical problems of old age, I can thank God for limiting my ailments to those I can handle instead of asking "Why must I suffer?" Prepare yourself for health issues.
Lifestyle Issue: Deteriorating Mental Health.
My mother repeatedly told me about her fear of dementia as she grew older. Toward the end of her life, she was troubled by her compromised cognitive abilities and her memory. Fortunately, she took a humorous attitude toward her disability, even when we needed to take her car keys from her. I confess to being troubled when I needed to discuss taking authority away from her, and I was relieved when she didn't berate me.
Both my parents died suddenly from cardiovascular problems, so they weren't plagued by an extended period when they were intellectually incompetent.
I don't want to force our son to deal with these issues involving our deteriorating physical and mental health any more than necessary, so we have attempted to plan[v] for our final days so he won't be presented with any more issues than necessary.
Lifestyle Issue: Denied Health Care.
This fear is a case of a discontinuity. The clear implication of the baby-boomer demographics, combined with the continuing increase in the cost of health care, is that the current Medicare benefits can't be supported in the future[vi]. My wife and I could probably, if necessary, handle the high costs of both health care and long-term care ourselves (without help from any government plan), although we might well run out of money before our deaths. My suspicion is that we may be forced to test that belief within the next decade. That's not my fear caused by a discontinuity.
My fear is that (of course, in the interest of the "greater good") we will not be allowed to buy necessary, supplementary health care even if we pay for it ourselves. This fear is founded on the egalitarian premise that, even if people have saved to pay for medical care, they should not be allowed to buy better care than those least able in our society. This already appears to be the case for some programs like MediCal.
A possible response to this situation is to go to a foreign hospital (in the way Canadians now travel to the US), but I worry about some provision that might severely penalize us if we do. The possibility of being denied buying medical care concerns me in a time of uncertainty about government actions; my cost/benefit tradeoff of a procedure that might extend my wife's life may be far different than a bureaucrat's belief in the tradeoff as measured on other people.
I suppose we could move to a non-US residence, but I'm probably too old to take some of the relocation actions other CMGers have already taken. So this is a worry that I just need to live with. I'll pray that it doesn't materialize.
Lifestyle Issue: Estate Plan.
After putting together an estate plan[vii], things will change on you. Obviously, the death of a designated executor will require some revisions. But more extensive changes may be required as a result of:
Estate planning is especially confusing in 2010 because the death tax is temporarily eliminated. However, the estate tax is expected to be reinstated, perhaps with changes - and possibly with retro-active application to the beginning of this year. Waiting to revise your estate plan until the situation becomes clear may be dangerous because existing plans may be applied in unanticipated ways[ix].
If you can ensure that neither you nor your spouse will die in the next few years, you won't need to keep revising your estate plan. For me, it's already been about three years since we put together an estate plan, so it's time for a complete revision. Oh well, at least we have enough assets to worry about what will happen to those assets - at least based on my current models.
Lifestyle Issue: Ability to Help Loved Ones.
Many of us concerned people have accepted (at least partial) responsibility for the success of people we love. In many cases, their successes require more than the money provided in our wills, and in some cases the responsibilities are for causes which we guide and encourage. In all cases, we retired folks worry about whether things will turn out OK after we are gone, especially with regard to people that depend on us for emotional stability[x].
As our associate pastor has commented to me, my wife and I have an "extended family" that includes many people with no familial relationship to us. We love them, and we keep trying to figure out how to ensure their success when we're gone. This is an agonizingly difficult issue (after all, it's a matter of life and death), and we argue and worry about it all the time.
Financial Issue: Decreased Benefits.
As I have previously documented in this series[xi], the costs of the current Social Security System, Medicare, and Medicaid simply can't be sustained as the Baby Boomers reach the age when they can retire. Most retirement financial models (including mine) assume that Social Security benefits and medical benefits will continue as currently provided (including the Social Security COLA - Cost of Living Adjustment). A major discontinuity in retirement planning would occur if the benefits were dramatically cut - perhaps down to zero.
This result could arise from a revision to the eligibility criteria that would simply cut off anyone with a retirement income above some level (e.g., the national average). More likely mechanisms would change some variables in the existing programs. For Medicare, the criteria for beneficiaries to pay increased costs for Part B and Part D could be decreased significantly so people with moderate incomes would then need to pay the extra premiums. For Social Security, the minimum age of eligibility could be raised from 62, and benefits could be decreased if retirees have other significant income.
Decreases in benefits from actions like these are often referred to as "means testing" for benefits because it is assumed that beneficiaries with adequate means should receive fewer benefits. This approach is especially popular with people who have small retirement savings, and it seems very fair to them. The argument against means testing is that it is basically unfair to collect large amounts from Americans saving for their retirement, and in exchange, to cut their benefits. If a family has spent all its income through the years on consumption (e.g., new cars, yearly updates to large TVs, flashy clothes), then it will have reduced assets in retirement. Why should they receive extra benefits in retirement taken from the folks who have saved for retirement?
The trade-off between the two views of "fairness" will need to be worked out over the next decade. Those people on the losing end may view the result as a "Black Swan event", but it really doesn't qualify because the need to deal with limiting costs is predictable (although I don't know the probability of each alternative outcome). All retirees (except for the extremely wealthy) are right to worry about this.
Financial Issue: Increased Taxes.
Do you believe that taxes won't increase at the Federal and State levels? If so, do you also believe in the tooth fairy?
Far too many promises have been made to far too many special interests to be honored unless taxes are increased. Many of these promises have the force of law, and they are unlikely to be broken (like public pensions and "other post-retirement benefits"). Because the commitments in many cases far exceed projected financial capabilities, what will happen? Some alternatives are as follows:
Maybe all these increased taxes will only be levied on the extremely wealthy (e.g., the top 5%) and leave the rest of us alone. However, the extremely wealthy have many ways to avoid taxes, and you and I don't have the same alternatives[xii]. The amount that can be collected from these people is probably far too little to fund all the desires of the politicians, so they'll need to come back to you and me to make up the deficit.
The amounts of these taxes would be very different from previous levels and types; they represent a discontinuity from previous levies. I worry about the impact of additional taxes on my budget during the years of my retirement; you should worry about the impact on you too.
Financial Issue: Unexpected Costs.
In addition to unexpected costs of medical care and increased taxes (both discussed previously), retirees like me worry about other costs like fuel for heating and driving, home maintenance like appliance malfunction and roof repair, auto maintenance and possible need for auto replacement, and relatively small costs like Internet access, TV cable service, and telephone service. In general, increases in these small costs are very difficult to project, if for no other reason that the suppliers of these services would like to hide the costs in order to collect additional revenue.
Some lucky retirees (e.g., in-laws of a friend of mine) have nice pensions (he is a retired state employee) that allow them to live comfortably and to luxuriously travel internationally at least once each year (along with several visits to their kids across the country each year). They worry about the cost of such leisure trips, but I neither feel entitled to such luxuries nor worry about the possible increases in costs of such activities because I don't have enough money to undertake them anyhow. Maybe you're more like them than like me; if so, I envy you.
Financial Issue: Unfunded Pensions.
In general, pensions for public employees have considerably greater legal support than private pensions. A private firm can go bankrupt and fail to pay its pensions, but government entities are generally required to keep their promises. Municipalities can also go bankrupt (in certain cases), so public pensions aren't automatically secure. For larger private firms[xiii], the PBGC (Pension Benefits Guarantee Corporation) provides insurance for private pensions, but benefits may be less than originally promised.
Government and accounting standards tend to require that private firms fund their pension plans very close to the required level. Standards for government entities are far less constraining, so they can keep increasing promises without putting the money into reserve accounts. As public employees retire in large numbers (many of them are in the "baby-boom generation" too), we will likely find that problems will occur.
My problem doesn't involve losing a pension, it's that I (as a tax-payer) will need to pay much larger taxes to fund pensions and other post-retirement benefits of other people[xiv].
Financial Issue: Decline of Value in Taxable Account, IRA, or 410(k).
If you have a generous pension and it's really secure, we salute you. For the rest of us, we worry about the value of our taxable account, our 401(k), our profit sharing plan, our SEP, our IRA, or whatever. When values are up, we exult that our future is secured. When they go down, we worry about whether we can depend on them to support us in our retirements, especially if we've invested our assets with someone like Madoff.
As we have experienced over the last few years, stocks can take a disheartening plunge in value. Even some bonds have suffered declines in prices[xv]. I anticipate that additional declines in bond values will likely occur in the future, especially in municipal (primarily tax-exempt) bonds. As noted above, government entities have huge pension promises to keep, and they may well be confronted with the need to choose between handling pensions or paying bond holders. Perhaps the Federal Government will increase its support of municipal bonds, but otherwise states might try to limit their payments on bonds. If bond holders will agree to take pennies on the dollar, then they'll be paid. Otherwise, they'll have to wait until they have their day in court in a decade or two. (This is the course taken in Argentina; it might work in the US by the states claiming that their bonds are held only by "unscrupulous tax evaders" because the bonds are largely tax exempt. However, it is unlikely that the Federal Government would do this; it can simply print money.)
The last two or three years have provided the opportunity for extreme apprehension by people close to retirement or actually in retirement (like me). I decided a number of years ago that I couldn't depend on a nice continuous valuation of retirement assets through time; something would go wrong even if I diversified. Therefore, over my wife's vociferous objections, I decided to continue working until we could suffer a 30% decline in valuation without the need to panic; that decline actually happened. I have been known to point out to her that I was right and she was wrong on this issue. (She's right and I'm wrong on so many other issues that she doesn't mind my comment very much.)
Anyone that concludes that the highest his/her valuation has risen is its "real value" and therefore decides to stop working is a fool. Before you decide you have adequate resources, see whether you can make it if 30% of the value disappears. You might even see whether you can still make it if 50% of your retirement assets disappear, especially if your assets are aggressively invested[xvi].
Financial Issue: Inflation.
The "value" of any financial instrument may stay constant in dollar terms, and still change significantly in real value[xvii]. The usual cause of the difference is inflation, the increase in the number of dollars needed to purchase the same goods. If you invest all your assets in bonds, then (assuming no default or change in prevailing interest rates) the price of your assets will generally decrease in inverse proportion to the inflation rate.
Knowing this relationship, people who believe that inflation will occur tend to buy goods earlier (rather than later) so they will be able to buy without paying an inflated price. If deflation (the opposite of inflation) is expected, then people will tend to defer purchases until later. In the latter case, economic activity will tend to be depressed (as in Japan). So a moderate inflation helps government officials keep the economy active. A problem occurs when government officials really, really want to do wonderful things (especially for friends, families, and favorite causes) but their revenue just won't support those things. The solution is to just increase the money supply by "printing money" (although in today's complex economy they don't need to be that blatant).
As more and more people in the baby-boomer generation leave the workforce, the production of goods will decline[xviii]. However, those same people intend to keep consuming pretty much as they have in the past, so demand will stay relatively constant. The result will likely be inflation throughout the world during the next decade[xix]. If the rate were only 1% or 2%, retirees could probably cope; if it is 5% to 8%, they will suffer significantly.
So do you want the "safety" of bonds, or do you want to invest in things that will increase in price as inflation occurs? I'm trying to maintain a mixed strategy that will limit my pain whether inflation is moderate or dramatic. But I worry about it.
Lessons Learned
In Conclusion
Footnotes
[i] An earlier article in this series deals with estimating your retirement expenditure level. It can be found at the following URL: http://www.cmg.org/measureit/issues/mit53/m_53_8.html.
[ii] This IRS requirement involves "distributing" at least a certain (age-related) amount each year. I offer some explanation at the following URL: http://www.cmg.org/measureit/issues/mit64/m_64_5.html.
[iii] In his book titled The Black Swan: The Impact of the Highly Improbable, 2007, ISBN 978-1-4000-6351-2.
[iv] The US may have problems to a lesser degree than many other countries. A huge amount of detail on this issue is available in the report "An Aging World: 2008" from the U.S. Department of Health and Human Services. It can be accessed at many sites, including the following URL:
http://www.census.gov/prod/2009pubs/p95-09-1.pdf
If you're pretty certain that you already know all about this, take the quiz on pages iii and iv to burst your bubble of confidence.
[v] Through living wills.
[vi] For an extensive review of the financial impacts of changing demographics in the United States, you can read a recent publication titled Choosing the Nation's Fiscal Future. It points out that continuing entitlement programs, as they are currently defined, simply can't be funded. It's ISBN is 0-309-14724-7, and I downloaded it from the following URL:
http://www.nap.edu/catalog/12808.html.
[vii] For discussion of estate plans, you can find extensive documentation on the web. In addition, you could look at my article at the following URL: http://www.cmg.org/measureit/issues/mit57/m_57_12.html.
[viii] The amount of the estate tax "exemption," and your estate's value, must be continuously monitored if you have a bypass trust.
[ix] Some warnings, and a discussion of potential actions, are given in an article on Joe Delano's web site. It's titled "2010 Estate Tax Update" and is available at the following URL: http://www.josephdelano.wfadv.com/
[x] As I have told my children, I ceased being dependent on my father the day he died. And I ended my dependence on my mother when she died. Dependence on human relationships is far greater than younger people usually understand.
[xi] My documentation is available to you at the following URLs:
http://www.cmg.org/measureit/issues/mit50/m_50_9.html
http://www.cmg.org/measureit/issues/mit51/m_51_1.html
[xii] Do you really believe that Bill Gates, George Soros, and Warren Buffet sit down in April each year and bring up TurboTax on their computers to file their income tax returns?
[xiii] Specifically, any firm to which ERISA applies.
[xiv] More information on pensions is available in my article at the following URL: http://www.cmg.org/measureit/issues/mit58/m_58_12.html.
[xv] My comments about plunging asset values can be found at the following URL: http://www.cmg.org/measureit/issues/mit56/m_56_13.html
[xvi] Unless you're a very sophisticated investor, careful asset allocation is advisable. My comments on that topic are available at the following URL: http://www.cmg.org/measureit/issues/mit54/m_54_10.html.
You might also think very carefully about risk and how to cope with it. My comments for that are at the following URL: http://www.cmg.org/measureit/issues/mit60/m_60_10.html
[xvii] Considerably more detail about inflation can be found in my article on that topic at the following URL: http://www.cmg.org/measureit/issues/mit52/m_52_5.html.
[xviii] According to STRATFOR (a very highly respected geopolitical analysis firm) the major driver over the next decade won't be terrorism or economic competition. It will be the changing demographics due to the aging baby-boomers.
[xix] For a more complete explanation of the causes of inflation, I recommend the book Money Mischief: Episodes in Monetary History by Milton Freeman, 1992, Harcourt Brace & Company, ISBN 978-0-15-661930-1.