Wednesday, April 1, 2009

The Federal Debt and Retirement Planning.

Last night, Frontline on PBS aired "Ten Trillion and Counting" , a documentary on the national debt. The picture isn't pretty. The debt had already ballooned under the previous administration due to a couple of wars and the Medicaid part D prescription drug benefit. Currently, bailout and stimulus payments are increasing the debt further. But the real problem is entitlements - Social Security, Medicaid and Medicare. Under current growth projections, these programs will consume most of the federal budget within just a few years.

The problem is two fold. First, our legislators have continued to expand these programs, because the programs are popular (and the legislators want to be popular as well). Second, the ratio of workers to beneficiaries continues to fall. Fewer people are paying in to the system relative to those drawing out of the system.

This is not really my area of expertise, but it seems that there are two solutions: Raise taxes or cut benefits.

In my personal retirement planning both of these will impact me (and most people) directly. First, higher taxes in the future means that I have uncertainty as to the value of my retirement portfolio which is made of pre-tax dollars. When I retire, I will have to pay taxes on these funds, and higher future tax rates will hurt my wealth. Second, part of my retirement will be funded by social security. It seems clear that the growth of these benefits will have to be curtailed, and when these benefits are paid will have to be delayed.

These two possibilities suggest that 1) it might make sense to put cash in a Roth IRA where the taxes are paid up front. This will reduce the "tax risk". 2) Lower benefits means that I will either need to put more away, or expect a lower standard of living when I retire.

Another question is whether the traditional retirement portfolio of mostly stocks is prudent. Zvi Bodie (one of the authors of the leading MBA investments text) argues that we have it all wrong in asset allocation for retirement. Rather than buying stocks, we should buy TIPs (Treasury Inflation Protected Securities). I'll write a blog post on his ideas in the near future.

In the meantime, it seems pretty unambiguous that we need to save more.