Planning for Retirement: Economic & Investment Environment, 2011

Planning for Retirement: Economic & Investment Environment, 2011 Dr. Thomas E. Bell, Retired TBell@RivendelConsultants.Com

Agenda (Too Long) • Long-Term Issues (Entitlements) • Unemployment & Economic Growth • Inflation • Taxes and Governments Issues • Bonds • Stocks • Implications

Social Security (OASDI)Pre 2010 To Social Security “Trust Fund” Bonds (Effectively Counts As Revenue To Feds) Employer “Contribution” Current Year Social Security Payments Employee “Contribution”

Social Security (OASDI)After 2016 2009 From Social Security “Trust Fund” Bonds (Effectively Counts As Expense To Feds) Employer “Contribution” Current Year Social Security Payments Employee “Contribution”

Shortfall to Pay Scheduled Benefits plus75 Percent Revenue Contribution to SMI Percentage of GDP

2008 Projections From Government

Will Social Security and Medicare Costs Get Too HIGH? 2008 Trustees’ Report Summary

How Social Security Benefits Are Determined Determining Individual Primary Insurance Amount Determining Maximum Family Benefit 2009 OASDI Trustees Report, Figures V.C1 and V.C2

Reducing Social Security Deficit Means-Test (Cap) Third bend point ($5,300) “Equity” 2009 OASDI Trustees Report, Figures V.C1 and V.C2

State and Local Governments • Usually don’t have their employees participate in Social Security, so they don’t have Social Security or Medicare entitlements (because they will be covered locally). • Typically underfunded (or unfunded) plans. • Local salaries are frequently unrealistic high, and bonds have been issued for questionable activities. • Many want “bail-out” from Federal Government, but resistance for this is great. • California, Illinois, and New Jersey are especially troubled. • Raising taxes is popular among politicians, but unpopular with tax-payers.

Required Investment To Achieve $4,000,000 in 20 Years With $1,000,000 Already In Fund Rate of Funding Implications Return Levels 3% 45.15% Need to contribute additional $1,214,703 now 5% 54.78% Need to contribute additional $ 507,558 now 7% 96.74% Need to contribute additional $ 33,676 now 9% 140.77% Can spend $286,276 to please supporters Note: Actuarial assessments are far more complex than shown here, and funding is provided through time. However, assuming a high rate of return reduces required payments to a pension plan and is a tremendous temptation to politicians who would love to spend more on items their supporters want. Then their successors can worry about how to fund pensions later.

Public Pension and Other Post-Retirement Benefits:A Threat to Your Assets Due to Taxes and Defaults • The baby-boom retirement surge will hit state (and county, city, and special district) personnel as well as everyone else. • California reported a 23% increase in state and local retirements (not including teachers) in 2010 • 1/3 of state and local workers with specialized skills are up for retirement in the next ten years • Need to fund retirement accounts for these personnel (many of whom have very generous retirement benefits) • “Just raise taxes” to pay for pensions and bonds sounds nice – unless you are a taxpayer or need to obtain taxpayer approval. • The story of higher returns over a longer period won’t sell much longer.

Some alternatives to handle bonds, pension commitments, medical care, and other expenses • Have unions agree to dramatic reductions in retirement benefits (not likely) • Have the Federal Gov. pay pensions for states in trouble (other, more responsible states, probably won’t agree) • Cut out many essential services (few politicians are likely to choose this) • Declare bankruptcy or equivalent (after amendments to laws) and offer pennies on the dollar to holders as in Argentina (such amendments hard to pass) • Have the Federal Reserve buy up Munis at reduced prices and only require issuers to pay low interest while not redeeming bonds. • Default on bonds after declaring that investors are all just speculators and don’t deserve anything anyhow (then don’t sell bonds for 10 years) • Put all retirement accounts (including government ones) into a single fund (administered by Social Security Administration), guarantee a rate of return, and then pay out benefits in a manner similar to Social Security. (Similar plan already proposed in Congress – as in Argentina.)

Implications • Promises are too great to be met, even with major increases in taxes. • The Social Security “Trust Fund” is a facade; money must come from the General Fund. • Both Social Security and Medicare may be “means-test limited” in the future. • State and local promises (for pensions and medical care) are inadequately funded, so they assume high returns on their investments to lower required contributions. • The problem is so large that you may need to plan for coping with radical solutions.

Summer of Recovery http://www.tradingeconomics.com/united-states/gdp-growth

Summer of Recovery 8.5%: Rate we might reach w/o stimulus

Summer of Recovery

Delay In Small Business Employment Change Sylvain Leduc, “Confidence and the Business Cycle”, Federal Reserve Bank of San Francisco, Report 2010-35, November 22, 2010

NFIB SMALL BUSINESS ECONOMIC TRENDS by William C. Dunkelberg and Holly Wade January 2011, page 19

Summer of Recovery NFIB SMALL BUSINESS ECONOMIC TRENDS by William C. Dunkelberg and Holly Wade January 2011, page 7

Summer of Recovery NFIB SMALL BUSINESS ECONOMIC TRENDS by William C. Dunkelberg and Holly Wade January 2011, page 4

NFIB SMALL BUSINESS ECONOMIC TRENDS by William C. Dunkelberg and Holly Wade January 2011, page 18

Congress passed or tried to pass a ton of legislation that had little to do with helping the economy. It is no wonder that consumers and owners are in a canyon of pessimism, the recession took a huge economic toll and the leadership inspired fear, not confidence. With the small business sector on the sidelines, it is hard to get national growth above the 2 to 3 percent range and the economy will not enjoy the type of rebound experienced after 1982 when GDP grew eight percent for over a year. With the threat of higher labor costs from the health care regulations (being written, so still not understood) and other labor directed regulations, policy is still a job creation depressant. A worker must be able to at least earn their pay if they are to be employed. Adding new labor regulations such as those in healthcare make this hurdle even harder to overcome. NFIB SMALL BUSINESS ECONOMIC TRENDS by William C. Dunkelberg and Holly Wade January 2011, page 3

Benefits’ Drag on Hiring Wall Street Journal, 05/02/2011 Note: Prior to costs, mandates, and regulations from ObamaCare

Late Information • Initial unemployment claims (5/5/2011) jumped to 474,000, up 43,000 from previous week. This is the highest rate in some time. • Cost of labor is increasing. • Economic growth is decreasing a bit. • Fed Ex survey of small businesses shows an increase in confidence over the long term. • Worry about stag-flation is starting to increase. • Deleveraging in commodities (5/5/2011) and end of Fed’s QE2 raise considerable uncertainty.

Wall Street Journal, April 12, 2011

Implications • Added “per employee” costs will motivate using individuals more efficiently and extensively – instead of hiring more individuals. • Small businesses are critical for increasing employment, but they don’t have the necessary confidence to hire. • Unemployment will decline, but slowly and over time. • Profitability of many firms will remain good as they improve their efficiency in using labor. • Gross Domestic Product will increase, but only slowly – not fast enough to satisfy governments’ desires for increased taxes.

Why Worry About Inflation?

Annual Inflation Rate Average Inflation (~3%)

Implications • Inflation is occurring around the world, and is almost certain to come to the US. • The Fed (Federal Reserve) wants to keep inflation around 2% (or above). We should plan for inflation over the next decades at 2% or more (probably 4% is safer). • As governments find refunding bonds difficult, the temptation to pay back with devalued dollars will be overwhelming. • Buying long-term bonds is probably unwise.

Source: http://wjmc.blogspot.com/2011/04/top-california-highway-patrol-salaries.html

California Prison Guards • Are paid $3,050/mnth to attend 4-month academy • Starting base salary between $45,288 and $65,364 • Earn time-and-half if over 40 hours per week • One sergeant earned $81,683 salary, $114,334 in overtime, and $8,648 in bonuses ($1,560 bonus for annual checkup) • Can save up vacation days; eighty officers cashed in over $100,000 each last year. • Defined benefit pension plan (guaranteed payments), can retire at 55 years with 85% of final year’s salary. Source: Wall Street Journal, April 30, page A13

California Prison Guards • Are paid $3,050/mnth to attend 4-month academy • Starting base salary between $45,288 and $65,364 • Earn time-and-half if over 40 hours per week • One sergeant earned $81,683 salary, $114,334 in overtime, and $8,648 in bonuses ($1,560 bonus for annual checkup) • Can save up vacation days; eighty officers cashed in over $100,000 each last year. • Defined benefit pension plan (guaranteed payments), can retire at 55 years with 85% of final year’s salary. • Over 120,000 applicants for 900 admitted to academy Source: Wall Street Journal, April 30, page A13

Why Do Governments Cost So Much? • Personnel, especially in Federal Government, are more competent than employees in the “private sector”. • Nearly any government expenditure has some benefits, even if very small. • General government mentality is often that people in the “private sector” are greedy, but people in the “public sector” have their focus on the public good. • Promote projects with strong near-term advantage (e.g., getting elected, getting higher level job) even if they are excessively expensive in long-term. • When necessary, raise taxes in an adroit manner (e.g., just tax the rich)

Federal Gov. Personal Income Tax and DeficitPersonal Income Tax Revenue (2008) Total Amounts (in $1,000,000,000s) Returns’ Adjusted Gross Income (in $1,000s) Data Source: IRS http://www.irs.gov/taxstats/indtaxstats/article/0,,id=129270,00.html

Federal Gov. Personal Income Tax and DeficitIncome vs Deficits Total Amounts (in $1,000,000,000s) Returns’ Adjusted Gross Income (in $1,000s) Data Source: IRS http://www.irs.gov/taxstats/indtaxstats/article/0,,id=129270,00.html

Federal Gov. Personal Income Tax and DeficitDouble Personal Income Tax Total Amounts (in $1,000,000,000s) Returns’ Adjusted Gross Income (in $1,000s) Data Source: IRS http://www.irs.gov/taxstats/indtaxstats/article/0,,id=129270,00.html

Federal Gov. Personal Income Tax and Deficit100% Personal Income Tax on AGI Total Amounts (in $1,000,000,000s) Returns’ Adjusted Gross Income (in $1,000s) Data Source: IRS http://www.irs.gov/taxstats/indtaxstats/article/0,,id=129270,00.html

AGI Is Too Low • Dramatically increase economic growth (>> 1.8%) so the increased AGI can be taxed, or • Change the definition of AGI by eliminating “Expenditures in the Tax Code”: “Tax expenditures are subsidies, tax credits, deductions, exclusions, exemptions and special preferential rates for individuals, business and corporations hidden in the tax code in that, once enacted, they do not have to be reauthorized or included in annual appropriations legislation.” (Rep. John F. Teirney per Huffington Post, April 21, 2011) • Just eliminate deductions like mortgage payments and charitable contributions. Then AGI will increase and provide more tax revenue.

Implications • Even making income tax rate 100% for all “millionaires and billionaires” (AGI > $200,000) would just barely handle 2011’s deficit. It would not cover the Social Security and medical costs of the future. • “Just have the millionaires and billionaires pay a little more” won’t make much difference. Another solution is needed. • Unless expenditures are significantly reduced and entitlements are decreased, higher income tax rates with reduced deductions will need to be levied. • Mortgage payments and charitable contributions will likely be eliminated or phased out at higher incomes. • Get ready for the impact!

Bond Interest Rates • The plunge in stock prices (and lots of mutual fund prices) frightened many investors away from those investments. • Money from sale of stocks went to buy bonds. That drove the prices of bonds up – and the yields down. • Investors were willing to settle for low yields because they felt bonds wouldn’t lose value or have volatile prices like stocks. • In the name of stimulus, the Fed has pressed yields down even more than they would have decreased due to investor preferences.

Planning for Retirement: Economic & Investment Environment, 2011