Don’t Count on Social Security or Medicare


Social Security is said to be the third rail of American politics.  A politician who even mentions cutting benefits risks being tarred and feathered.  Perhaps the greater evil than threatening to cut benefits is to act like you won’t need to.

Right now there is a great looming liability hovering over the US Government.  As Cox and Archer discuss, Social Security and Medicare benefits are projected to cost about $85 T more than they take in from payroll taxes.  You see, Social Security was designed to be a pay-as-you-go system where the money taken in from current workers goes to pay for current retirees.  This works fine if there are the same number of people in the population at any given time.

The issue is that there are a huge number of people in the Baby Boom generation who are starting to retire, and far fewer people coming after them who are working.  This generation paid more than enough to fund their benefits, but all of the extra money was spent on other things, leaving only a set of IOU’s in the vault.  This would be fine if the money were actually loaned out to entities who could be expected to pay the money back, but since it was lent to the Government itself, if the Government is not making enough in current tax revenues to pay Social Security benefits, it won’t be able to pay the IOU’s either.  The inability, or non-desire of recent graduates to get a job and start paying into the system is only exacerbating the problem, as has the record number of people going onto Social Security disability in recent years.

The issue with Medicare is even worse.  The taxes on Medicare have never been enough to pay for the nearly limitless benefits that are provided.  As is the issue with all medical insurance, because the recipient pays the same no matter what, there is no incentive to keep costs down.  It is doubtful that many people would pay $300,000 out of their pockets for a surgery that would extend their life by a year, even if they had it sitting there in the bank.  Because the bill is being paid by Medicare, however, the cost does not matter.   Having a lot of people who are not paying, and having doctors who prescribe a lot of procedures out of fear of lawsuits if they don’t and do things in an inefficient manner to jump through the Medicare hoops also doesn’t help.

For many years the trustees of Medicare and Social Security have been warning that the programs will soon go insolvent.  Now, with US debt approaching the point that we will be unable to borrow any more, and with both Social Security and Medicare starting to pay out a lot more than they take in, it is perhaps a matter of only a couple of years before we’ll see severe cuts.

Despite this looming certainty, there is no warning coming from the politicians who should know better.  It is evil to tell people they will receive an income and healthcare when they are old and unable to take care of themselves when it will not be there.  This is like leading a group of people out into the desert, telling them there is a resort waiting for them so that they come only prepared for the walk out, and then leaving them there without water or food.  Perhaps if people know that there will be no $1600 check coming in each month or Government-provided health insurance, they will do things differently while they are still young and working.  They will save more.  Children will make plans of how to take care of Mom and Dad.

Much was said about “Mathematics” during the campaigns this fall.  The levels of obligations far exceed any revenues that could be generated by taxes.  The math is very simple and very clear that the party will be ending soon.  Now is the time to start planning for a future without Social Security and Medicare.  Cut expenses.  Don’t buy a house you can’t pay off before you are retired.  Save enough to be self-supporting when you are older.  If you have aging parents who have not saved, start planning on how you will take care of them, perhaps getting an extra room in your house ready.  Acting like an osterich with your head in the sand will not change the math.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Are You on a FIscal Relative Maximum?


In mathematics there is a concept of a relative maximum.  A relative maximum is a region in a function where the function decreases in every direction,but it is not the highest peak.  For example, if you were on top of a mountain in North Carolina, you might think that you were on the highest place on Earth since the land as far as you could see all around you sloped downward.  There are peaks in the Rockies, however, that make the highest peaks in the Appalachians seem like hills.  Then there are peaks in the Himalayas that make the Rockies seem like hills.

People tend to also find relative peaks financially.  There are many people who are on unemployment who could start working again, but think they have it better not working.  They would only make a little more, or even maybe make a bit less, if they went back to work.  They would need to pay for clothes and gas, and miss out on time with friends.  People may stay on welfare their whole lives because if they make too much money, they lose their welfare benefits.  It seems like they are stepping down in their situation.

Likewise, many people have good jobs, but spend all of their money on stuff.  They eat out a lot.  They take lavish vacations.  They have every technology device known to man and spend thousands each year on subscriptions.  They spend every dollar they have each month and then run up the credit cards to finance the rest.  They think that if they were to buy an older car, or eat in more often, or drop their cell phone plan, they would be reducing their standard of living.  They see any reduction as leaving the peak.

The thing is, there is always a decline when you leave a peak.  It is also a hard struggle to climb up to the next peak.  It is difficult to leave a job to get an advanced degree.  It is hard to leave welfare and start working for a living.  It is difficult to eat in and drive used cars when everyone around you is eating out and buying new cars every three years.

But when you do so, you find higher peaks.  You leave welfare, work your way up in a company, and suddenly are earning $80,000 per year instead of getting $20,000 per year for “free” from the government.  You leave a clerical position paying $35,000 per year, spend a couple of years in school earning nothing while you get an MBA but then land a management job paying $60,000 per year.  You move out of your parents home and suddenly need to pay for your own rent and food, but you get the freedom and sense of pride that comes from being an adult rather than a 20-something teenager.

You drive an older car, eat your lunch at your desk, cook at home most nights, and stay in an apartment for a few extra years while you save and invest.  When you are 40, however, you have a paid-for house and $500,000 in investments when all of your friends have no equity in their homes at all and $30,000 in credit card debt.  You buy a vacation home for cash while your colleagues are all wondering how they can get rid of their time shares.  You have $5000 in extra income coming in each month from investments and can send your kids to college with your cashflow while your friends kids are taking out student loans.  You have the peace of mind that you could be just fine if you lose your job, while your friends are trapped working, knowing that their lifestyle would start to come crashing down if they missed a single paycheck.

Are you really on top of the world, or are you just at a relative maximum.  Would things be better through that valley on the peaks on the other side?  Are you able to make that climb?

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

photo:  Martyn E. Jones

The Fiscal Cliff and the Debt Bomb


Much todo has been made about the Fiscal Cliff.  For those who have been in a cave for the last month, the fiscal cliff occurs at the end of the year when both the tax cuts enacted under the Bush administration in 2003 and the peanut-butter spread spending cuts enacted last summer by Congress go into effect.  This is expected to have a severe effect on the economy.

The expiration of the tax cuts mean that the tax rates will go up for everyone, since the tax rates were cut in all brackets.  There were also increases in things like the child tax credit, increases in the amounts that could be invested in IRAs, and other tax breaks that will also expire.  Probably the most important for readers of this blog is the increase in divided tax rates from 15% back to ordinary income levels.  This means that for some of the taxes on dividends will go from 15% to almost 40% – pretty tough on grandma who is living off of her investment account.

On the spending side, there are large cuts to the Defense budget.  These will hit government contractors the hardest, even though they are only a small part of the workforce, since the ones allocating the money will probably opt to let contractors go before cutting civil servant positions.  The effect on defense readiness also has been called into question by defense personnel up to the Defense Secretary himself.  Certainly increasing the likelihood of an attack and reduced national security will not be good for the economy.

The current spitting match is between Democrats, who want to raise taxes and raise spending, and Republicans, who don’t want to raise taxes and don’t want to see Defense cuts.  It is very likely that Republicans will agree to tax increases, maybe just deduction elimination for those making above a certain income level in exchange for reducing or eliminating the Defense cuts.  Democrats will declare that the increased taxes will help reduce the deficit and allow for “investment” in things like education and jobless benefits.  There will also be promises of spending cuts, but these will never come.

The fiscal cliff, however, is really not important, when compared to the debt bomb.  Unless spending is actually cut – not just cuts in the amount of spending increases planned in the future, the country will face a real problem in about four years.  The tax increases proposed are advertised to bring in about $1 T over the next 10 years.  Note that this predicts that the tax increases will not affect earnings and incomes, which is probably not the case, and that a future administration won’t just change tax rates again, which is also probably not the case.  Even if the taxes really do bring in another $1 T, however, the amount added to the debt over that time will be between $10 T and $15 T.

To put this into perspective, imagine that your family has an income of $35,000 per year and debt of $160,000.  You are spending $45,000 per year, so each year your debt increases by about $10,000.  Even though you have incredibly low interest rates, you are still paying about $4500 in interest every year, which is difficult on an income of $35,000.  It will get worse if interest rates go up, which is very likely given how much debt you have and that interest rates are currently historically low.

Now let’s say that you start selling baskets at a craft fair and start making an extra $100 per year.   You now make $35,100 per year, but you are still spending $45,000 per year, so your debt is still increasing by $9,900 per year.  In ten years, your debt will be $259,000 instead of $260,000, as it would have been if you had not started going to that craft fair.  This is exactly the effect that the increase in taxes of $100 B per year will have.  You are increasing revenues by $1 T over 10 years, but you are overspending by $10 T-$15 T over that same period.

The real debate that should be going on is what spending will be cut to eliminate the deficit within the next 3 years.  Otherwise, within 4-5 years we will no longer be able to borrow more and the interest payment on the debt will start to approach the amount spent on Social Security.  This will jeopardize national defense and all social services, including Social Security and Medicare.  Inflation may soar, wiping out the savings of those who keep their money in the bank and money markets.  This will be particularly hard on those in retirement living off of their savings.

This is the real cliff, and both Republicans and Democrats are stepping on the gas, Thelma and Louise style.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Photo credits:  Colin Broug