Are You Ready for “The Future of Retirement?”

In her blog post last week, Linda Robertson wrote about her experience at this year’s ISCEBS Employee Benefits Symposium and in particular, a presentation by former U.S. Comptroller General David Walker about “The Future of Retirement.” Walker spoke about the growing national debt and the impending insolvency of the Social Security, Medicare, and Medicaid programs. He then argued that it will take a combination of both tax increases and benefit cuts to dig our way out of the hole. To the degree that we don’t take these steps, we could see higher inflation by either the government trying to print money to cover the debt and/or investors dumping the U.S. dollar in anticipation of or reaction to a devaluation of the US dollar. So what does this all mean for us?

Higher Taxes

Regardless of who wins the elections this November, get ready for higher taxes. First of all, the Bush/Obama tax cuts are scheduled to expire at the end of this year. Even if they’re extended, at some point the government is likely to need more revenue to help close the budget deficit.

While Mitt Romney is advocating more tax cuts, a new study by the Tax Policy Center showed that the rate reductions in his plan would require eliminating enough tax deductions to actually raise taxes on about 95% of Americans in order to achieve his goal of revenue neutrality. For that reason, be careful of investing in cash value life insurance and municipal bonds since their tax-free status may be on the chopping block. The same goes for the mortgage interest and property tax deductions so make real estate purchases assuming the tax break won’t be there. You may also want to consider contributing to a Roth account to protect yourself from higher tax rates in the future.

Lower Benefits

According to Medicare’s trustees, the program’s trust fund is projected to be depleted in 2024. That’s why new GOP vice presidential candidate Paul Ryan drafted his now famous plan to reform Medicare and Medicaid. Unfortunately, the Congressional Budget Office estimated that his reforms would increase out-of-pocket medical costs for each retiree by about $6,400 per year. In addition, his Medicaid cuts could restrict long term care eligibility and reduce the number of facilities willing to accept Medicaid patients due to lower reimbursement rates. But even if Ryan’s plan isn’t enacted, President Obama’s Independent Payment Advisory Board has been assigned the task of looking for ways to keep Medicare costs from rising above target levels. Either way, try to save more to cover these higher health care costs and consider purchasing your own long term care insurance policy rather than relying on Medicaid.

The same goes for Social Security, whose trust fund is scheduled to run out in 2033. That doesn’t necessarily mean you won’t see a dime of it though. There should still be enough tax dollars coming in to fund about 75% of the promised benefits so that’s what I like to assume when running retirement calculations. Of course, that number could change if the government decides to increase Social Security taxes, raise the retirement age, and/or reduce benefits more for higher-income people but I think expecting a 25% lower benefit is as good an estimation as any.

Higher Inflation

Higher inflation usually means higher interest rates so consider locking into fixed rates on mortgages and other loans while rates are still at or near historic lows. You might also want to avoid long term bonds and make sure you have adequate exposure to foreign investments (at least 20%) and assets like TIPS, real estate, commodities, and precious metals (at least 5%) that can act as a hedge against inflation. If you purchase an annuity or annuitize a pension plan, look for inflation-protection even though it means a lower payment now.

What if none of this happens? Maybe we’ll miraculously discover some new way to wipe these problems away and live happily ever after. I wouldn’t count on that though. As they say, it’s better to be safe than sorry.

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