The Coming Changes in Government Retirement Benefits
In recent months, as the country debated the federal government recent debt ceiling issue, I have had discussions with many people about the federal government retirement programs and the problems they present to the country. The big question is, if and when these programs will change in the future. These programs affect how we plan for our own retirement. In this post I will provide some government figures and my thoughts on this issue. The reader, as always, can make his/her own assessment.
In discussing the federal government retirement programs, e.g., Social Security, Medicare, federal employee pensions, etc. with others, I’ve come to realize that a lot of people are not aware of the scale of the problem. Many people seem to think that we can just end foreign aid, reduce fraud and abuse, cut some defense spending, and increase some taxes on the wealthy and that will solve the problem. In fact, the future government obligations are so large that, in addition to these changes, modifications will have to be made to the federal old age programs. I do not know how these programs will change. But I am certain that they will change, regardless of who wins future elections.
Why am I so sure changes are coming? Let’s do a high level examination of the federal government finances.
Currently the federal government (i.e., the American people taxpayer) has a cumulative debt of about $10.5 trillion owed to the public (i.e., foreign central banks, private banks, pension funds, and individual investors). If you include debts owed to all the different federal agencies (the largest of which is the social security trust fund), the total federal debt is currently about $14.8 trillion. According to recent Congressional Budget Office (CBO) figures, in the federal government’s 2011 fiscal year just completed, the government took in about $2.5 trillion in revenue but spent about $3.8 trillion. The $1.3 trillion difference was made up through borrowing funds from other sources. This means in fiscal year 2011 the federal government borrowed about 35% of the money they spent in 2011 and added that amount to the federal debt. This is financial madness on a scale never before seen in history. Unfortunately, the current federal debt is only the “tip of the iceberg” of US liabilities.
The current $14.8 trillion debt represents money spent in the past. The federal government has made future promises that are much bigger than the current debt. These promises are for various programs including Social Security, Medicare/Medicaid, federal government employee pensions, veteran’s payments, and other entitlement programs. Future total liability estimates vary, but the “Present Value” of all future federal entitlement liabilities has been estimated at between $60 trillion and $120 trillion. Present Value is a calculation of how much funding must be in the bank today, accumulating interest, to be able to pay all the promised benefits over the assumed time frame. The different estimates are due to different analysis assumptions such as average life expectancy, future economic growth rates, different discount rates, and the number of years included in the analysis (most analyses assume a period of between 50 and 75 years). These future government liability estimates are anywhere from 4 to 8 times greater than the current debt the country has already incurred (it should be noted that about 15% to 20% of the current $14.8 trillion debt includes treasury securities owned by the social security trust fund; these securities are to pay future social security obligations). Regardless of how these figures are calculated, it is clear that the government’s future liabilities are very large.
What makes the situation worse is these future liabilities are all “unfunded” liabilities which mean there are no assets set aside to pay for these obligations. Social security and the federal/military employee defined pension plans each have an accounting of what benefit is owed to each retiree, but there are no hard assets set aside to pay these benefits; only the government’s promise to pay.
To put this $60 trillion to $120 trillion unfunded liability in perspective, one needs to compare it to the net worth of all households in America. On page 6 of this 2009 Federal Reserve Publication, the aggregate household net worth of every person in America including Bill Gates and Warren Buffet fell in 2009 from about $64 trillion to $53 trillion due to the financial crisis. If this estimate is accurate, this means that if the government made a claim to 100% of the wealth of every American (i.e., all savings accounts, stock portfolios, real estate equity, and non-public corporate assets); it would not be enough to pay the estimated future government promised liabilities. This situation brings new meaning to the term “unsustainable.”
The obvious question that comes to mind is, “What will the government do to address this situation of overwhelming debt and unfunded liabilities?” There are calls for tax increases on the highest income citizens. Undoubtedly this will happen, but this step alone will not solve the problem. According to Table 1 of the “Fiscal Facts” compiled by the non-partisan Tax Foundation , if you tax the top 1% income earners (roughly everyone who earned over $344,000 in 2009) at a 100% rate, this would only increase annual tax revenue by about $1 trillion more than this group already pays in taxes. This is not enough to offset the $1.3 trillion deficit incurred just in 2011. And, of course, it is not realistic to think that the government would increase the tax rate on any income group to 100% as they would all just stop working. It may be possible to raise an additional $1 trillion in tax revenue by increasing taxes at all income levels. But this also would be politically difficult to do. In any event, it is clear that to make just a small dent in this fiscal tsunami that is headed our way, it is necessary to reduce government entitlements in some way. Of course any changes will be delayed as long as possible, but I don’t think it will be another decade before major changes occur. I believe no one currently 70 years old or younger will escape the changes entirely.
If you are currently over 55 years old, I do not think that the federal retirement programs will change radically unless you are extremely wealthy, but any change could be significant. So, in planning your retirement, I think you should assume that the current benefits of the federal programs will not be as generous in the future. If you are currently under 50, I think the changes to the federal retirement programs will likely be much more dramatic, especially if you have any other significant income in retirement. As I have stated before, those of you who have saved diligently for retirement are going to be made to pay for those who have not. I know it is not fair, but it is just the way it is going to be.
So how am I adjusting my retirement planning to the coming federal program changes? I am in my mid-50s and I am assuming that my social security benefit will be, in real terms, equivalent to about 50% of what the Social Security Administration currently says my benefit will be. If you want to find out what your current social security benefit is estimated to be, check this social security site. I have also assumed that, due to escalating health care costs as well as program changes, my “out-of-pocket” health care costs at 65 will be, in real terms, the same as they are today. That is, I am currently paying 100% of my health care premiums with total health care costs of $13,000 per year (including deductibles and co-pays) for both my wife and myself. I am planning to continue to pay this amount, in today’s dollars, out of my own assets even when I am on Medicare at age 65. This means I am assuming that my Medicare benefits will represent a much smaller federal subsidy than current retirees receive from Medicare.
In any event, the sooner everyone accepts the high likelihood that changes are coming to the federal old age programs and prepares for those changes, the better off they will be.
In my next post I will discuss my biggest retirement fear.
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