The Trouble With Retirement

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When the
government offers something for nothing, watch out. There is going
to be a ringer in the system.

The government
offers income-tax deferral for certain kinds of government-approved
investments. The great advantage of these programs is that they
allow tax-free compounding. If your fund’s investment portfolio
grows in value — a huge if — you are not taxed until
you sell the portfolio and start living on the income. Presumably,
you will drop into a lower tax bracket at the time of your retirement.
This assumes: (1) no price inflation; (2) the tax code isn’t re-written
to raise tax rates.

One major
problem with tax-deferred investment programs is that the money
is channelled into government-approved investments. This money
balloons these subsidized markets upward until such time as a
significant percentage of people want to retire. Then they start

How large
a percentage is "significant"? I don’t know, but I think
10% will be enough. The people who are invested in these government-subsidized
markets got in early. Their capital gains are high, on paper.
New investors must pay top dollar to buy the old-timers’ assets.
There will not be enough of these new buyers to replace the capital
of millions of sellers, dollar for dollar.

When the
retirees’ selling starts to produce a panic, new buyers will stay
out. Those still invested in the subsidized markets will at last
grow weary of hanging on for the long term. They will be too gray.
They will sell out prematurely, before they retire. This will
compound the contraction.

At that point,
income-tax deferral will not work as a slogan to lure in more
investors. There will be too much risk. The Ponzi-scheme nature
of the retirement strategy will be exposed. There will not be
enough well-heeled investors to buy out the old timers, whose
dreams of easy living in retirement will go the way of all government-subsidized


We can see
that the government cannot balance its budget, yet the politicians
are eager to get us into a retirement program. Why?

One reason
is that the public pressured politicians to do it, primarily through
profit-seeking intermediary pressure groups (retirement plan management
firms). We all want to delay the day of reckoning.

Another reason
is that the politicians are willing to defer a tax just so long
as they will eventually be able to collect it. It is a kind of
"forced saving" by the government. They forgo the revenues
this year in order to skim the funds at the point when you retire.
The problem with this theory is that there is so little deferred
gratification elsewhere in politics that it is difficult to imagine
it here.

A third reason
is that the IRS and Treasury bureaucrats see the potential benefits
mid-term. They know that Americans are happy to declare anything
they own, just so long as they receive tax exemption. Americans
do not think twice about the government’s demand that they fill
out forms, keep records free of charge, and limit themselves as
to what they will invest in, if only the bureaucrats promise —
cross their hearts and hope you die –that they will leave these
retirement accounts sacrosanct.

By getting
Americans to save more, the bureaucrats to some extent help the
economy to boom (assuming that investment creates growth, in contrast
to the Keynesian myth of consumer spending’s creating wealth).
Interest rates can be kept lower, since entrepreneurs are presented
with a larger supply of loanable funds, if the resulting federal
deficit (heavy borrowing) doesn’t offset the increase.

But, more
to the point, the bureaucrats get their potential victims to put
trillions of dollars into easily monitored accounts that usually
are managed by government-regulated third parties — firms
that are ready to comply to government demands in order to reduce
the threat of IRS investigations or other regulatory pressures
on them.

When the
size of this newly created pot of invested wealth gets large enough,
the government can then sit back and wait for a scandal or two.
Maybe some fund manager runs of with the funds. Maybe he invests
in some crackpot scheme and loses most of the funds he managed.
Maybe personally managed accounts are mismanaged by government
standards. Maybe in the case of corporate retirement plans or
long-term Keogh plans, the firm’s owner mismanages the funds of
his employees, and the government can highlight such mismanagement.
You know: Enron Plus.

The government
then will create a new series of debt instruments, "Guaranteed
Retirement Bonds." These bonds are bought with maturities
that equal the number of years remaining on each worker’s expected
retirement (to age 59, or 62, or 65). Then the government will
issue new regulations: each tax-deferred retirement plan manager
must invest 25%, then 30%, or even 40% of the funds in these guaranteed,
fixed-interest bonds, for safety’s sake.

The government
will then skim hundreds of billions of dollars worth of long-term
notes. The bureaucrats thereby will get access to the money, and
yet avoid outcries, since the psychology of resistance is lowered
to such confiscation. After all, New York City unions consented
a quarter century ago to the union pension funds buying New York’s
"Big MAC" bonds in order to save the City from legal

It is this
psychology of deferral which is crucial. People want immediate
tax relief, yet they are only marginally concerned with distant
returns. Wealthy people would not put so much money into "tax
shelters" if this were not the case. Avoiding immediate pain
is high on everyone’s list; avoiding distant losses is far lower.
Ludwig von Mises called this general phenomenon "time-preference."
I call the desire to avoid immediate taxation "bait."
It sells well to fat mice.


A lot of
voters keep hoping that the deficit will somehow be reduced without
a crisis or higher taxes, yet without major spending cuts in their
personal pet projects. So they think to themselves, "Well,
maybe things will get better later on. Maybe tax rates will be
a lot lower when I retire. If I can defer getting hit with today’s
high rates, and we can get Congress to back off later on, then
I will wind up with more money when I retire."

It might
be true. Maybe there will be some way to achieve this miracle.
Also, maybe there will be a collapse, and your personal retirement
fund somehow survives, and a gold standard is restored, and then
deflation hits, and tax rates aren’t raised, and you "cash
out" with lots of real wealth, untaxed. Maybe. Probably not.

But people
keep hoping. A tax deferred could become a tax avoided. In any
case, it defers the pain of paying immediate, visible taxes. People
are willing to take tremendous risks in order to achieve this.

Will there
be a way out before the confiscation plans long-term federal retirement
bonds — are imposed? Will your personal retirement portfolio
survive the crisis, and still be there, purchasing power fully
intact, for you to prosper when you are least able to defend yourself?
Will you find a way out?

My suggestion
is this: don’t open a retirement program, until you have a plan
for avoiding the pitfalls, especially official emergency political
pitfalls, that today’s deferred tax retirement programs offer

Here is what
you need to ask yourself, minimum:

  1. How
    many years until I think I will retire?
  2. What
    is my goal for the after-tax retirement capital base?
  3. What
    could I do with the after-tax money instead?
  4. How
    much will I have to contribute per year?
  5. What
    rate of return I expect to get?
  6. Will
    I be totally dependent on this nest egg?
  7. Will
    I retire into an inflationary or deflationary world?
  8. Will
    I retire into a controls-produced shortage economy?
  9. How
    flexible will the program be?
  10. Who
    will make the major and minor investment decisions?
  11. Will
    others be covered by the program?
  12. What
    will my legal liabilities be to these others?
  13. Do
    I really want these liabilities?
  14. Will
    the bureaucrats change the rules?
  15. What
    will the penalties be for premature liquidation?
  16. What
    criteria should I use to liquidate the program?
  17. Will
    my psychology allow me to pay the penalty?
  18. Will
    it become illegal to liquidate the programs?


I offer this
rule as the foundation for any government-approved, tax-deferred
retirement program: assume in advance that you will liquidate
it before you retire. If you are age 55 or more, you have no big
problem. You are allowed to liquidate a Keogh or IRA at age 59.5
without paying a penalty. They are unlikely to change this rule.
If they do, liquidate immediately and pay the penalty.

I don’t think
they will go from the present 10% penalty to "illegal to
liquidate" overnight. The bureaucrats understand that the
real inhibiting factor is that 50% of ordinary income that you
will have to pay, not the paltry 10%. If this factor were not
strong, people would not go into these programs in the first place.

To brace
yourself, you need a psychological ploy. Here is my recommended
ploy: always mentally reduce the equity in your fund by the amount
of tax you would have to pay. You don’t have $250,000 in the fund,
you have $150,000, or whatever you would have left over after
the tax bite of your ordinary income bracket. Learn to think this

Then you
tack on the 10% penalty, or whatever it is raised to, and assess
the damage of premature liquidation. But you must always discount
the capital base by the liquidation costs. If you don’t, the bureaucrats
will probably suck you in "for just a few years more."
They will get your money, and then increase the penalty for early

Want to know
what I really think will happen? The worst-case scenario? A demagogue
gets into office and pushes an emergency order (which Congress
will not override) which deposits all these funds into the Social
Security system, for everyone who has a net worth (not counting
home ownership) of [$ ]. Fill in the blank with
whatever the tyrant thinks he can get away with. We could see
an envy-grab of the retirement programs of the upper middle class.

As I said
before, I don’t think this will be done overnight. There will
have to be a major crisis for any President to risk this sort
of emergency action. But it is during such emergency-type conditions
that you need access to your funds; they should be liquidated
before the Federal government’s fiscal crisis gets so bad that
some tyrant is willing to take such a risk.

The time
to start thinking about a premature liquidation is when a new
President is elected on a radical platform, probably with a shift
in Presidential political parties, and with both houses of the
new Congress belonging to his party. Alternatively, after a President
is assassinated, or after he resigns in the midst of a fiscal
or monetary crisis. In the first case, liquidate at least by the
week preceding his inauguration. In the second case, liquidate
a few days after the newly inaugurated President’s reassuring
addresses to the nation have sent the stock market up 30 or 40
points from the assassination or resignation low point, but before
he gets around to rewriting the tax code.

Another time
to start thinking about it is when the price of gold goes over
$1,500 per ounce, in response to three or four near-bankruptcies
of major oil companies, banks, or Fortune 500 corporations.

If you start
reading about more major scandals in managing retirement programs,
start getting ready to liquidate. The orchestrated press will
have to be whooped up in advance. This happened with Enron. It
can happen again.

Never forget,
Congress has the fattest retirement program in the land. They
will not rely on corporate funds to
tide them over, at least not those who have been re-elected three
or four times. They take care of their own. They are not under
Social Security. So whatever they do to the rest of us will not
affect them.

Anyone who
is not psychologically ready to liquidate, or who has no mental
criteria to force his own hand, should not get into any retirement
program more high powered than an IRA.


Will you
really need the money when you retire? In short, do you really
intend to retire? Not if you’re smart. Your number-one priority
should be to create a home business into which you will "retire."
You will simply shift the percentage of your time which is devoted
to jobs A and B, with 100% of your work days going to job B. What
I recommend is retirement avoidance.

I think there
will be increasing demand for independent contractors along the
lines of "Kelly Girl" and "Manpower." I think
it will pay entrepreneurs to set up firms that hire retired experts
part time. I guess I might call it "Old Coots and Geezers,
Inc." (If the Rolling Stones can still dodder onto the stage,
thinning hair, and all, then why not the rest of us?)

Let me give
you an example. My father is a retired FBI agent, Hoover era.
For years, until he hit age 80, he worked part time for a very
savvy firm, M.S.M. Security, Inc., of Lanham, Maryland, which
figured out that there was a bank deposit full of money lying
around in the form of retired FBI agents and other retired professional
investigators. The company started lining up retired agents all
over the country. Then it went to the Department of Defense and
offered to do the screening of high security placement personnel
that the Air Force or other armed forces might want to hire or
promote. The military’s internal screening program, being bureaucratic,
is comparatively slow and expensive. M.S.M. can cut the screening
time by something like 60% to 70%, and cut the costs accordingly.
It can sell this service profitably. This also frees up full-time
military personnel for other jobs more closely associated with
national defense. The company hires skilled retired agents who
spent a career doing this sort of work, and pay them an hourly
wage, plus travel expenses. These men are glad to get the supplementary
income. The government retirement program at the moment is generous,
so they don’t have to be paid full-time professional wages. I
see this sort of company springing up all over the place as the
economy gets into crisis mode.

If you are
a "knowledge professional" (as most newsletter subscribers
are), there is no reason short of laziness, enormous wealth, or
Alzheimer’s disease which will prohibit you from staying in the
work force at least a decade after retirement age. Your first
retirement strategy is to decide not to retire and plan accordingly.
I think that the best tax shelter is starting up a business that
provides tax-deferral opportunities as part of its basic structure.
(Mail order firms offer long-term development opportunities along
these lines.)

If you can
free yourself from the dark cloud of forced retirement, and therefore
from the limitations of retirement income (capital consumption),
you then can start talking about how to structure a tax-deferred
retirement investment program.


How should
you look at your retirement program? As a nest egg (emergency
fund)? As a way to get untaxed capital growth (the "miracle
of compound growth")? As a way to get the money needed to
fund an already operating small business after retirement? As
a way to finance a real estate empire after retirement? What?

I have a
distinctly unconventional approach to this question. I see a retirement
fund as a dual fund: (1) mental back-up for higher-risk investing
today, or (2) as a high-risk capital growth vehicle for a person
with good income possibilities.

Let me give
you some examples. If you are willing to take Saturdays or week
nights for building up a family business over a ten-year period
(or more), then your retirement fund should be a high-compounding
vehicle to supply you with "mental reserves." Your real
goal is the growth of your second business. You need to develop
the skills of business management, entrepreneurship, and all the
other skills that go into operating an independent business. That
retirement fund soothes your wife’s fears. It also is legally
immune to bankruptcy proceedings, should that grim possibility
ever occur. You can say to her (or yourself): "If I fall
on my nose with the second business, at least I will have reserves
later on."

On the other
hand, maybe you are a physician or other self-employed professional.
Or maybe you can "take your job with you" when you retire.
Maybe you are a consultant now. In this case, you don’t really
need to retire at age 65. This is just what everyone needs. Your
job with your retirement fund to take advantage of the tax-deferred
status of the fund. You need fast capital growth, compounded.
You need a solid chunk of it in high-risk, high-return speculative
ventures, on the understanding that you could lose the whole thing,
or 50% of it, if your guesses are wrong.

In both
cases, you need goals. You need a much larger goal for your crap
shoot, since only a large goal justifies the risks. But you need
to be able to sit down at the end of each year and see if you’re
"on target." If you need 15% per year growth, see if
you have achieved it. If not, are you willing to stick with the
program on the assumption that you will hit 100% next year? But
you need to re-evaluate it every year, and if you failed to meet
your goal, you have to think about shifting to a lower goal (which
I don’t recommend), or change managers, or stick with it, but
by raising the annual return that you’re trying to achieve (because
you didn’t achieve it this year).

If price
inflation soars again, you will need to re-evaluate your after-tax
retirement-day capital base. It will have to be increased, and
so will your per capita appreciation numbers.

It is far
easier to sit down and set goals with a retirement fund than with
anything else. It is a strictly "dollars and cents"
evaluation. A business has many side-effects, good and bad. It
has psychological inducements. To evaluate the success of a business
in terms of mere dollars is ridiculous, if it’s your business.
But a retirement program is cut and dried. You set it up in terms
of a supplemental strategy to your overall life plan. As a supplemental
capital base, it must be evaluated coldly. Has it increased according
to the plan in each year? If not, why not? And what to do about

It is the
formation of your long-term capital goal which takes the greatest
concentration. You must be realistic. You need a contingency fund,
of course, but for major emergencies, your retirement fund will
not be sufficient. Don’t expect it to be sufficient.

The ultimate
contingency fund is your children. If you become a total basket
case, either your children or the State (ha, ha) will protect
you. Your money will not survive a major catastrophe — not
the way today’s full-time professional medical care in a "rest
home" eats up a budget, unless you have at least $1,000,000
in reserve, pulling 3% per annum. If your children aren’t able
to care for you, there’s not much your nest egg will do after
two or three years.

But, on the
assumption that you will still be functioning productively at
age 80 — and you should pace yourself on the assumption that
you will be — then you need a goal for that retirement capital
base. Get it down on paper before you open anything more grandiose
than a simple IRA.


What I am
trying to get across is that your tax-deferred retirement fund
is strictly a supplemental program. If you expect it to support
you in the future, you are probably making a mistake, unless (1)
you have a lot of income that can be legally deferred, (2) you
can continue to do this for well over a decade, (3) you make few
investment mistakes, (4) the government-approved markets for retirement
programs stay solvent, (5) the government doesn’t change the rules,
and (6) you don’t suffer a stroke or other major illness.

You have
to decide what your tax-deferred retirement investment program
is to supplement: (1) a long-term occupation from which you need
not retire, or (2) a higher-risk family business that might work
out as the long-term employment source that you had better be
looking for. Your program should compensate for your primary source
of expected future income. If your expected future earning source
is high risk, the retirement program should be a high-return but
conventional program. If your future employment income stream
is reasonably likely to continue after retirement, then adopt
a "go for broke" program.

1, 2003

North is the author of Mises
on Money
. Visit
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