Thinking of retiring? Think again. Thanks to the “financial repression” practiced by the world’s leading central banks, generating adequate income in retirement has become problematical. What’s financial repression? “Financial Repression” is defined by Investopedia as “measures by which governments channel funds to themselves as a form of debt reduction” by keeping interest rates low. Current 10 year Treasury bonds yield 0.50%. In the Euro area, 10 year bonds yield 0.0 while in Japan 10 year bonds are actually negative – you pay them to keep your money.
What does this mean to you? You are around 50, you and your spouse earn $150,000 a year. Life is good. One of you is a teacher, expecting a state government pension of say $40,000 a year when you retire while the other has fully contributed to the company 401k and has accumulated $500,000. You should be set in 15 years, right? Your 401K will grow to over $1 million, and advisors say you can safely spend $40,000 from that without fear of running out of money. You’ll have say $36,000 a year in Social Security and add in the pension of $40,000 your annual income will by $116,000 a year. You think you can make it on that, what with your mortgage paid off, not paying Social Security Tax, no lunches at work or commuting costs. Maybe not high on the hog, but you’ll be ok.
Wrong. Thanks to these low interest rates and anemic economic growth, it is unlikely you’ll double your 401K in 15 years, even with say another $150,000 in contributions. The bond interest component of your fund will grow only a couple of thousand bucks. Stocks? They’re at record highs, partially due to these interest rates. Add in a couple of recessions in the next 15 years, and you will be lucky to have $700,000 at retirement.
How much income can you safely draw from $700,000? At these interest rates maybe $10,000 a year. Leaving you with $86,000 a year, a little tight, especially since you will still have a mortgage because you refinanced to fund your kids college education.
But you’ve still got that safe state government pension, right? How safe are pensions when bond yields are barely positive? Pension funds, both public and private (but not the Feds – they can print money) are typically invested in bonds and stocks, maybe 60/40 or 50/50. If bonds yield 1% and stocks yield, say 4% over the next 15 years, pension fund return would be about 2.5% a year. Pension funds take the money paid in by participants and invest it, growing it so there is enough to meet the promises to pensioners. Pension funds make assumptions about return in order to gauge what must be paid in by the organizations and participants. Many funds assume high rates of return, say 8 or 9%, to lower what the organization (government or company) must contribute. As a result, many pensions are underfunded. But if returns continue to be very far below expectations, the organizations will have to raise their contributions, by a lot in some cases. Governments may have to raise taxes to meet these obligations, as has already seen in Illinois and other financially irresponsible states. But if these interest rates continue for 15 years, the tax increases required in some cases may be so high that it will be politically and economically impossible to continue payouts without reductions. See Detroit and Puerto Rico.
So, where are you if that state pension is cut? Good thing you can rely on Social Security. But hey, no one likes to fly commercial, so you can stay home and avoid the TSA lines in your golden years.