Retirement Rescinded – Part Two

In Part One of what is now starting to look more and more like a diatribe against tax-sheltered retirement plans, I discussed some of the problems that I believe are common to employer-sponsored, defined-benefit pensions plans as well as IRA and 401k plans.

Part of my issue with IRAs and 401k plans has to do with what I believe is a long-term bias that can turn into a disaster.

Of course these vehicles are a terrific way to reduce taxes during your earning years while allowing those funds to grow unmolested by taxes.  On the other hand there is no guarantee what the tax rate will be at the time of retirement when withdrawals begin.  So while there should be a net tax savings, that amount cannot be determined for certain prior to retirement.  Tax laws and rates change.

For young people these financial instruments are great.  And a market crash correction is a blessing for those in their 20s and 30s as they get to load up their funds with stocks when they are cheap. And the longer stocks stay depressed, the better.

(It is highly improper any more to speak of a market “crash.”  These declines are now just “corrections.”)

The situation folks approaching age 60 and beyond face is a very different one from those just beginning their careers.  A market that drops 40% the year you retire followed by ten years of moribund growth can be a disaster as your time horizon is very different from the 30 year-old.

And here’s my gripe.  Due to the regulations governing IRA and 401k accounts, there is a limited set of strategies individuals can employ to hedge against a major correction.  And a hedge is something that could be wise as people near or enter retirement.  Should that crash correction happen — and they do, you know — things could get unpleasant really fast.

I keep saying it — people forget how risky common stocks can be.  If you’re a retiree or hope to be one in the next 10 years, look yourself in the mirror and answer these questions:

  • Do I have a plan in place to reconfigure my portfolio, whether tax-sheltered or otherwise, to preserve my wealth in the event of a 40% to 50% market crash correction from which the overall markets will not recover for 10 years?
  • Will I be able to time the implementation of this strategy so I miss most of the draw-down from the crash correction?
  • Or will I do what many do — sit there and hope things turn around?
  • Or will I wind up selling at the bottom in desperation to preserve what’s left?  This is too often what happens.

Maybe you have so much money that a 50% haircut doesn’t matter to you.

Remember that bonds are not immune to market moves.  And the interest US treasuries earn doesn’t even keep up with inflation – if you use honest inflation figures.

I’m very worried.  But maybe that’s just my nature.

My point is simple — the long-term bias that served the IRA and 401k investors so well for decades might turn around and bite them just when they need those funds.

Being in a tax-sheltered fund limits the options to “tail-hedge,” or otherwise take specific actions to keep from being road-kill when the next crash correction arrives.  There are tail-hedging strategies that involve derivative plays and other vehicles that simply cannot be employed in a tax-sheltered fund.

So in an effort to supposedly reduce the amount of risk permitted in your IRA, those making the rules might have instead actually prohibited you from reducing that risk.

I’ll get more specific on this in the next post in this series.

As always, thanks for reading.

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Retirement Rescinded – Part One

What is the likelihood you’ll receive in your retirement the amount you anticipated?  And just how safe are your retirement funds?

It should come as no surprise that all retirement plans depend on earning returns on the principal while funds are being added during working years as well as when funds are being withdrawn during retirement.  If those earnings are below what was anticipated, then the plan has been under-funded and something has to give.

I’ve previous discussed in this blog the massive under-funding of government retirement plans and, indeed, health care plans such as Medicare. Anyone who is not aware that these programs are in serious financial trouble is just not paying attention — or just doesn’t want to think about it.

Even Alan Greenspan, not one of my favorite persons, is sounding an alarm, “Alan Greenspan, former chairman of the Federal Reserve, said the global economy’s inability to produce goods and services efficiently is going to cripple the ability to pay for pensions and health programs for the elderly.”  Alan, where were you when the alarm needed to be sounded at least a couple of decades ago?

And a sluggish economy contributing to reduced investment returns is only one of the problems besetting these government programs.  Over-promising benefits would be another.

Okay, so chalk off Social Security and Medicare.  Not entirely, but at least at their promised benefit levels.  That’s strike number one against our current and future retirees.

Plans sponsored by businesses and unions aren’t in much better shape as the 400,000 members of the Centrals States Pension Fund have learned.  As I’ve pointed out before, this education regarding under-performing pension funds is going to be spread far and wide in the coming years.  Central States is just one preview of coming attractions. Grandmas and grandpas today are not going to have as carefree of retirements as my grandparents enjoyed simply because defined benefit pension plans have not generated the returns needed to provide the benefits at the levels promised.  Strike two.

But what about IRA and 401k plans? What’s the deal with these?

Well, to start off with, there’s a mindset out there bordering on hysteria that suggests that these retirement funds might be frozen, seized, have their terms changed by government regulation, or otherwise rendered less valuable than anticipated due to a national financial crisis. Lurid possibilities are presented typically accompanied by the recommendation that folks should close these accounts, take the tax and/or penalty hits, and stuff the money in gold bullion held personally. Nonsense.

Well, almost nonsense. Sort of.

I’ll assume my readers know what 401k and IRA plans are.  If you’re unclear, just click on the terms in the previous sentence and the folks at Investopedia will get you up to speed. These plans offers a highly desirable means for building funds for retirement unmolested by taxation until it’s time to draw out funds in the golden years.

So what can go wrong?  Plenty.

First, a 401k or IRA can suffer from the same problem as the other retirement plans I just mentioned – investment returns below expectations resulting in either an accelerated draw-down rate during retirement, or a shortened time horizon over which the retiree can expect to receive benefits.

Second, if you are paying someone to manage this for you, they are taking fees which reduce your returns. Of course those performing this service deserve their pay, especially when successful. Advisers will have several model portfolios and will recommend the one that their research indicates looks best for your particular situation.

That said, I believe there is a bias present which defines success as beating a particular index. Which means that if the index to which your fund is compared drops by 4% and your fund drops by 3%, your investment is deemed a success for the relevant time horizon.

There’s also a long-term investing bias. For those beginning their investment careers, this can be a great thing, and these folks get to buy low during market corrections.  (We are no longer allowed to have “crashes.”)  And one can take the perspective that the deeper and longer the correction the better – when you’re young.

But if you’re 60 t0 65 and your fund takes a 35% haircut, it will be years before you get back to even.  This will result in sleepless nights.  And the possibility of corrections in the amount of 35% or more have not been repealed.

I’ve said it before, people do not realize how risky common stocks can be. And if your IRA or 401k are full of the things, your retirement, to the degree you are depending on withdrawals from those funds, is in danger of disappointing very badly.

I will quickly be remonstrated for not pointing out that folks near their retirement years should have a very different portfolio than someone who’s 25. Okay, I just pointed it out, and I agree.

But I will also point out that this is not my grandparents’ market where satisfactory returns can be earned on 10-year treasuries, bank certificates of deposit, and utility stocks. Try stuffing your fund with those now and you had best have a much larger principal on which to draw interest and dividends than most have.

So people chase yield.  Or attempt to trade the equity markets in their retirement funds in the hope of ramping up the return to something that allows withdrawals to provide the living standard they had hoped for when they started the plans.

I’m going to let those thoughts sink in for a while before I continue with some specific reasons I dislike IRA and 401k plans – which I’ll do in Part Two.

 

 

 

 

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Retirees Are the New Endangered Species

Sunday morning here in the Midwest sees the local iHop busy with folks just getting out of church. Many of those customers are senior citizens –  retirees. If I’m right, this will change over the next few years. Why and it what way are topics I plan to address in the coming months.

People underestimate the probability of things going terribly wrong for the economy or for their own finances. Maybe they don’t have the capacity to work through what they would do if their finances blew up. Perhaps they think that their pensions, 401k and IRA funds, and Social Security are secure. Perhaps they have no point of reference when it comes to mass failure of institutions on which they had placed their financial hopes.  Whatever the reason, the hope and confidence that millions have placed in financial intermediaries and governments for a secure retirement are going to turn to disappointment and despair.

Thing are already getting frayed at the edges. For example, how many members of the Teamsters Central States Fund expected to get a cut in retirement benefits by at least 60%?  Can other pension funds blow up?  Of course.  And they will.  We just don’t know who’ll be next and when.

Pension funds are massively underfunded, just like Medicare and Social Security.  Benefit cuts are assured.  Retirees need to have at least a Plan B if not a Plan C to implement in case they are determined to be “too wealthy” to continue to receive full Medicare or SS benefits.  Means testing is likely.

There is no agency that can backstop even a very small percentage of private pension funds if they go insolvent.  Well, the government could just print the billions or trillions needed and put the money into people’s bank accounts.  But we know what that would cause.

I’m not the first one to say it, “The most endangered species in the US is the retiree.”

Surviving this pension fund pile-up is more a matter of getting the underlying causes of market moves and disruptions right so the right strategy is employed at the right time.  Such information will likely not be provided to the retail investor by the brokerages.  I mean, did they issue the warning in 2000 or 2006-08?  Okay, so why would one think they would do so now?

So we all have to ask ourselves what we’d do if the value of the income we receive in our retirements were to drop by 50% or more.  What if the components of one’s IRA or 401k cratered and the government stepped in to “bail you out” by replacing the securities in your retirement fund with 30-year Treasuries earning 3% that cannot be sold or redeemed until maturity?

Maybe it won’t happen.  Maybe it will be worse.  Even if I were a world-class expert at analyzing macroeconomic data and government statistics, what good is that if the data is manipulated?

Those of us who are not yet retired need to get to work on this at once.  One possibility is creating a micro business that one can carry into retirement.  After all, there are only so many stores that need greeters.

I the pension disaster materializes as I expect, Grandma and Grandpa will be off to iHop one Sunday morning, but this time as employees rather than as customers.

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