In 2017, I penned a piece for FedSmith reviewing the largest retirement risks that the federal work force would face in their golden years. Just a half-decade later, the hierarchy of these risks – particularly which of them are most likely to have a large impact your retirement – has changed dramatically. Let’s revisit these risks as retirement planning has recently been forced to evolve in order to address the confluence of a number of macro-economic forces, black swan events and demographic changes.
While the original article does a great job defining each risk, in this follow up we are looking to highlight the economic factors impacting these risks and how these factors change their rank in our hierarchy today. The primary factors that have changed our Retirement Risk Hierarchy are: Debt, Demographics, Inflation, and Interest rates.
National Debt
When I wrote the original article in 2017, our national debt was only $20 Trillion dollars. That was a concerning number at the time because, even without the pandemic, our fiscal trajectory projections forecasted that this debt would keep increasing over the coming years. Then the pandemic blew a $6 Trillion hole in the economy in 2020 and Congress issued unprecedented debt-financed stimulus as a result – which increased our “national credit card balance” to more than $30 Trillion. It took 200+ years to rack up $20 Trillion in debt but just 5 short years to increase it by 50%!
Demographics
Population growth is key to supporting entitlement programs like Social Security and Medicare, but our population is no longer growing, it is aging. When Social Security was first implemented, there were roughly 42 workers for every 1 Social Security recipients, now that ratio is 2.7 workers for every 1 Social Security recipient… and dropping. In the year 2034, for the first time in American history, the number of adults over the age of 62 will outnumber the population under the age of 18.
Inflation
Inflation can erode the value or worth of every dollar you save if the cost of goods and services goes up faster than your money grows. The Federal Reserve targets 2% year over year inflation, but because of the combination of stimulus, supply chain issues, and the pandemic forcing an emphasis on goods rather than experiences (new couch instead of a vacation), inflation has spiked to a 40-year high of 7.9% in Feb 2022 and is expected to increase further in March with the inclusion of a spike in the price of oil. Since Medicare, Medicaid, and Social Security are all inflation adjusted programs, high inflation further increases the cost of existing entitlement program benefits.
Interest Rates
Rates have been trending lower since the 80’s, but the FED raises interest rates to tamper inflation when the economy is running “too hot”. With inflation above 7%, the FED has signaled for 3-8 rate increases in 2022. Servicing the national debt at historically low interest rates already costs the nation $429 Billion per year and has already been the fastest growing line item in the budget. What happens when annually increasing levels of debt get compounded by an increase in the cost of borrowing? Nothing good!
Some of these risks have not changed much relative to how different the world is in 2022 as compared to 2017, but a few of these risks have grown so significantly that they needed to be expanded upon in our amended list of concerns.
Retirement Risk Hierarchy in 2022
Risk #1 – Taxation
The risk that future tax rates trend higher has become the number one concern for most federal retirees as they look to maintain their income into retirement. Pension payments and traditional TSP distributions are not only taxable, but they commonly make 85% of Social Security taxable as income too! This robust retirement income is often robustly taxable if no tax planning is done! See, the Tax Cuts and Jobs Act put income taxes “on sale” for 8 years starting in 2018 – which means that taxes are expected to revert back to the higher pre-TCJA rates when the sale ends at the start of 2026. The expiration of this tax sale will increase your bill from the IRS but it won’t generate enough revenue to fix our nation’s fiscal trajectory, unfortunately.
We already have a record level of national debt (which will only get more expensive as interest rates rise) and our aging demographics imply that there is no “light at the end of the governmental spending tunnel” as the cost of entitlement programs continue to increase in the coming years. As more baby boomers become eligible to receive benefits, remember too that inflation is further compounding the cost of providing those benefits each year. That said, many experts anticipate that Uncle Sam is more likely to increase tax revenue than reduce entitlement program benefits for political reasons.
Risk #2 – Inflation
Inflation is a hot-button topic right now because in March of 2022 it is expected to near 10% with the combination of pandemic fueled supply chain issues, stimulus money, and geo-political strife causing the cost of oil to explode.
In the near-term, inflation is a major concern eroding the spending power of our nest egg savings and fixed incomes. In the long-term, it is causing less alarm because (based on the information available today) experts expect that our aging population (and the resulting work force exodus) will act as a deflationary pressure that normalizes or offsets these “transitory” short-term inflation concerns.
Risk #3 – Sequence Risk
This risk is often overlooked because it does not exist until you begin taking retirement distributions. It is the risk that you experience negative market returns at the start of retirement and are forced to compound those losses as you begin taking regular retirement distributions.
Since 1929, a Bear Market has occurred roughly every 5.2 years and averaged a 39% drop in the S&P 500. If you draw the short straw for retirement dates and have a Bear Market occur immediately after your decision to retire, you may very well face 100% of your retirement with only ~61% of your money, and, as you may imagine, that is not a recipe for sustained success!
Risk #4 – Public policy risk
This is the terminology used to describe the risk that Uncle Sam might change the rules of the game. This section is largely unchanged from 2017 as these are cost saving measures are still being discussed in 2022 to help Uncle Sam lower his annual expenses. Previously mentioned potential changes still include:
- Decreasing Social Security, Medicare, or Medicaid benefits
- Changing IRA, 401K, or Roth IRA contribution limits or RMD rules
- Decreasing retiree benefit calculations or COLA computations
- Further suppressing the G Fund returns
- Subsidizing less of a federal retiree’s (and survivor’s) FEHB premium
Risk #5 – Interest Rate risk
This risk goes hand in hand with inflation. Can the G Fund, in today’s low interest rate environment, provide enough growth to keep up with inflation? Not with inflation above 8% – not even close!
Now, while you may have leveraged lower rates to lock in a great 30-year mortgage, Uncle Sam doesn’t have that same ability. Our national debt is more akin to a VARIABLE rate mortgage – meaning that as the FED increases interest rates, the cost of our existing National Debt will face a commensurate increase shortly thereafter.
Additionally, as we enter a rising interest rate environment, it poses a distinct risk to bond holdings. When interest rates increase, a bond’s sale value often decreases as newer bonds would be issued reflecting the higher interest rates. Learn more about Interest Rate Risk and your TSP here.
Risk #6 – Healthcare and LTC risk
We often think of protecting our nest egg, specifically from market losses, but let me ask you this: if 20% of your money disappears overnight, does it matter if it was due to market loss, a medical emergency, or a nasty bingo addiction? In 2022, as in 2017, the answer is NO! The impact on the sustainability of your retirement lifestyle is the same if you lose 20% regardless of how! Addressing healthcare and Long-Term Care risks cost-effectively is often accomplished with the combination of emergency funds, insurances (such as flexible life insurance policies with Living Benefits), and specific Asset-Based LTC strategies.
Risk #7 – Longevity Risk
Longevity Risk still comes last because the risk of living longer than you had planned is not just a risk… it is a risk multiplier! All of the risks already discussed continue to increase the longer we live! Do not set yourself up to have too much life at the end of your money, educate yourself by working with a federal retirement professional to help you design a personalized retirement plan for you and your family!
