Saturday, August 28, 2010

Long Term Consequences On Government Decisions.

When government passes bills the consequences are often not seen for years, in fact when they are truly felt very few will ever understand the connection the consequences have with the legislation. Most will never know, no less understand what happened and why. This is why it is so dangerous and frightening to see these massive unread bills get through. Who knows what and when the consequences will be?

Let's look back to two major changes that came about in 1973 that we are truly feeling the consequences of now, but will even more so in the next few years. One was a legislative change with the ERISA laws, the other a Supreme Court Decision Roe v Wade. It would have been difficult in 1973 to see the profound ramifications these two decisions would cause in our lives, or that they in any way related to each other. However, together they have helped create a perfect storm for our seniors.

The ERISA laws dealt with changing the retirement plans of our nation's employees, it allowed companies to shed the cost of creating and funding the defined benefit plans our grandparents retired on, the proverbial gold watch and company fixed retirement program. This is when we as a nation changed from the defined benefit plans to defined contribution plans and a self-funded retirement of IRA's, Keoghs, SEPs, and 401ks. We forced everyday Americans to become investors however we never got around to teaching them how. This is what has created our retail investment industry of prepackaged mutual funds and fund managers and what has pushed the Dow to record levels for years.

When these new defined contribution plans went into effect the IRS wanted to know when they would see their taxes on those deferred income deposits, so the law spelled it out. When you turn 70 and one half years old, by law, you must start withdrawing money from you retirement accounts if you need it or not so that money can become taxable. The Required Minimum Distribution or RMD is calculated by age and amount in the fund. See below.

"The table shown below is the Uniform Lifetime Table, the most commonly used of three life-expectancy charts that help retirement account holders figure mandatory distributions. The other tables are for beneficiaries of retirement funds and account holders who have much younger spouses.

Joe Retiree, who is 80, a widower and whose IRA was worth $100,000 at the end of last year would use the Uniform Lifetime Table. It indicates a distribution period of 18.7 years for an 80-year-old. Therefore, Joe must take out at least $5,348 this year ($100,000 divided by 18.7).

To calculate the year's minimum distribution amount, take the age of the retiree and find the corresponding distribution period. Then divide the value of the IRA by the distribution period to find the required minimum distribution.

Required minimum IRA distributions

Age of retiree Distribution period (in years) Age of retiree Distribution period (in years)
70 27.4 93 9.6
71 26.5 94 9.1
72 25.6 95 8.6
73 24.7 96 8.1
74 23.8 97 7.6
75 22.9 98 7.1
76 22.0 99 6.7
77 21.2 100 6.3
78 20.3 101 5.9
79 19.5 102 5.5
80 18.7 103 5.2
81 17.9 104 4.9
82 17.1 105 4.5
83 16.3 106 4.2
84 15.5 107 3.9
85 14.8 108 3.7
86 14.1 109 3.4
87 13.4 110 3.1
88 12.7 111 2.9
89 12.0 112 2.6
90 11.4 113 2.4
91 10.8 114 2.1
92 10.2 115 or older 1.9 "

Now how does this impact us today?

The baby boomers have been the driving force of our economy since their birth and will continue to be for some time. In 2012 the first birth year of baby boomers will turn 70.5 years old and required by law to start their RMDs. If you look at the above chart you can see that they will be in their peak RMD years pulling their money out of the market through their 401ks and IRAs. That birth year will add 2.5 million people to the RMD requirements. Then for the each of the next 18 years 2.5 million more will join them pulling out their RMDs. This will have to create an impact on the stock market with all of these people cashing in with a smaller pool of younger workers putting in. Another question is how long will the younger workers keep putting money in if the market falls due to all of those RMDs.

Compounding our situation is the baby boomer drain on the Social Security program. When it was founded it was there were nearly thirty people paying into the system for every one who received benefits. The average length of time Americans were on Social Security was eighteen months from the date they retired until they passed away. Today, we are at about three people paying in for each who is taking benefits, and the average life expectancy is continuing to expand adding further strain on the system. Maybe that is the real idea behind Obamacare, shortening those lifespans to save money. In 2022 the Social Security program will be operating on a one to one ration, with only one paying in for each one drawing out. That was when most expected it to bankrupt, however this year it is already bleeding negative cash flow twelve years earlier than thought.

Also in 1973 Roe v Wade became law by Judicial mandate, I know that isn't how laws are supposed to be made, but let's not focus on that right now. What does Roe v Wade have to do with the Social Security and ERISA laws? It is simple math, those two programs are crashing due to the massive baby boomer generation pushing them over the edge. However, if we had not had Roe v Wade there would be 49,551,703 more Americans who would have been born since 1973. Those people would be working, buying homes, cars, clothes, and making defined contributions into their own IRAs and 401ks and having their income taxed for the Social Security program. If these babies weren't aborted we wouldn't be looking at the financial abyss facing us in the next few years.

So okay, these are the numbers, and they don't look good, what should we do about it?
Let me suggest looking to history once again to where a great deal of wealth was made. As the stock market fell, as millions of homes, land, and businesses were foreclosed, those who had money, or at least access to money, bought land. They bought Real Estate, there is only a finite amount, there will never be any more available than there is today. With prices and interest rates at the lowest we have seen in several decades, anyone who can purchase is setting themselves up for a ride on the inflation train when we actually start into recovery. Once again there will be massive fortunes made buying Real Estate. Just a tip, do as you see fit.

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