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Age Pension - A Pyramid Scheme Doomed to Collapse

Jan 24, 2017

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The Dow is oh-so tantalisingly close to 20,000 points. Let's just get it over with and break through this psychological barrier.

The positive momentum will take the Dow higher by a thousand or more points before succumbing to the reality that the world is in a deflationary bind, and company earnings do not justify these lofty valuations.

The All Ords is certain to follow the Dow's lead. Perhaps it, too, will breach the psychological 6000-point level before economic gravity takes over.

Gold is staging a recovery from its 20 December, 2016, low of US$1,125 an ounce. Gold finished on Friday at US$1,175 per ounce. As I mentioned in The Daily Reckoning on 3 December, 2016, my thinking is that gold will put 'egg on the faces' of those who (extrapolated the prevailing trend and) forecast further losses.

Over the Christmas/New Year break, there was plenty of media coverage on the impact of the tougher age pension asset test that came into effect on 1 January of this year.

Unfair. Heartless. Politicians should practice what they preach. Cease Centrelink payments to Muslims with multiple wives. Hardworking Australians, who have paid taxes their entire lives, are being punished.

Taking money away from people - especially the elderly - is never going to play out well in the media. When emotion and logic line up for a debate...emotion wins nearly every time.

The cold hard fact is that the age pension, in its current form, is not sustainable.

It's a pyramid scheme...doomed to collapse under the weight of payments not being matched by tax receipts.

Readers of The Daily Reckoning tend to be independent thinkers...looking for a perspective not found in the mainstream.

In acknowledging this, let's dispense with the emotion and look at the logic.

If you're affected by the new asset test, you may not like the logic, but, as they say, 'it is what it is'.

A few years ago, I wrote a three-part series titled 'Farewell Welfare'. I've updated the series with new data from the latest budget, as well as the government's 'Retirement Income Consultation Paper'.

Today is the first part of the updated series. The purpose of the series is to forewarn you of what's coming. Further crimping of age pension payments is not an 'if, but or maybe'...it's an absolute ironclad certainty. The numbers do not lie.

Jack Canfield, co-author of the Chicken Soup for the Soul book series, said 'I believe that people make their own luck by great preparation and good strategy.'

Understanding the dynamics that are going to impact (negatively) on your retirement enables you to prepare and develop a strategy based on realistic expectations - whether it's to work longer, save more, or invest more astutely.

When you dodge the 'reduce age pension' bullet that'll hit so many of your peers, they'll say that 'you were lucky'. But luck had nothing to do with it. Forewarned is forearmed.

Here's the first part of the series.

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Society's slip into complacency

Is 'welfare' a Latin interplay for 'fare well'? Many people on social security - age pension, unemployment benefits, disability payments, and so on - would argue very strongly that they do not fare all that well on the taxpayer-funded payments they receive.

The term 'taxpayer funded' has been used deliberately. Most people define and describe social security as a government payment.

But government - unlike the private sector - does not actually generate revenue.

Government is a tax collector and redistributor.

The following is a pie chart from the '2016 Budget Papers' showing the various pockets the government picks to generate its $417 billion 'revenue' it then redistributes.


In 2017, over 50% of this tax revenue is earmarked for health and welfare spending...an expense of $230 billion.

An ageing population in the Western world comes with a significant tax cost. With wave after wave of baby boomers waiting to receive their gold watches, the largesse of future (and as yet unborn) taxpayers is going to be tested to breaking point.

Boomers that are expecting the social security and healthcare status quo to be maintained should heed this wake-up call - the numbers do not add up.

Boomers are a spoilt lot; I should know, I am one.

We've lived a relatively charmed life. Free tertiary education; affordable housing in our younger years; access to a variety of employment opportunities; rising asset values (shares and property); travel opportunities; access to a first-class healthcare system; and inheritances courtesy of frugal parents.

Compared to our parents, we boomers have had a dream run - no Great Depression or World War to live through.

The absence of genuinely hard times (in economic terms) led to complacency.

Hyman Minsky's 'Financial Instability Hypothesis' determined that stability leads to instability. This is the academic version of 'familiarity breeds contempt'.

If asset values rise each year, the stability in price action leads people to believe this constant appreciation will continue forever.

In effect, every year, another deck is added to the house of cards. The longer the house of cards remains upright, the more added decks there are.

Year after year, boomers built on the prosperity of previous years. Secure in the knowledge that stock and property markets would do the heavy lifting on savings.

More debt for consumption and investment - home equity loans, lines of credit, margin loans, credit cards, retail store financing, etc. - was added to household balance sheets.

While all boomers played the game, a positive feedback loop was created.

Complacency bred contempt in the form of subprime lending. Property prices never fall on a nationwide basis...or at least that was the prevailing idea at the time. Total disregard of prudent financial principles provided the perfect environment for these destructive mortgages to be (firstly) sold to unsuspecting borrowers and, worse still, for these loans to then be securitised to unsuspecting investors. Ratings agencies, Wall Street and central bankers completely lost their moral compasses.

Decades of stability created instability.

The golden years of debt-funded consumption are behind us. Ironically, it was this willingness to consume more than what we earned which provided the government with the revenues to finance a rather generous (and very costly) social security system.

But that was the past.

The boomer retirement years lie in wait. The boomers' working years were built on solid post-Second World War foundations that were laid by their frugal parents. The foundations for the boomer retirement years are far less stable and predictable:

  • Massive private sector debt overhang will dampen economic growth.
  • Low interest rates and growth rates will not provide sufficient returns on retirement capital to meet living expenses.
  • Heavily-indebted governments will not be able to fund current welfare and healthcare promises. Without the assumed government safety net, boomer retirees will need to rely more heavily on their own capital.
  • Longevity - perhaps living longer without sufficient money - is not going to be the 'nirvana' medical science many thought it would be.
  • Historical valuation methods strongly indicate that US stock markets are significantly overvalued. A severe correction (without a subsequent Federal Reserve engineered recovery) will lead to greater levels of despondency, as portfolios suffer sustained losses.
  • Over the coming decades, Gen X & Y (with higher education debts and crippling mortgages) will continually remind us how they begrudge having to pay higher taxes for boomer excesses and indulgences. When Gen X & Y are old enough to influence public policy - within the next 10 to 20 years - watch for a pick-up in the pace of change to government entitlements.

They say 'everything old is new again'. Perhaps our notion of retirement could also be altered in the coming years.

The birth of retirement

Keith Ambachtsheer (founder of KPA Advisory Services Ltd, and Director Emeritus of the International Centre for Pension Management at the Rotman School of Management) traced the concept of retirement back to the second half of the 19th century...the time of the railroad boom.

The growing number of railway accidents caused by aged operators (working until the day they died) grew to an unacceptable level. To reduce the rate of mistakes, railroads pensioned the aged operators out of active service. In the beginning, retirement was recognition that a worker had reached their use-by-date.

That concept has certainly changed over the past 100-plus years. The advent of social security in the early 20th century enabled more people to retire. From these humble beginnings, retirement is now its own economic sector...feeding a variety of industries (travel, financial, retirement homes, etc.).

But have we reached a point where society's concept of retirement requires reconsideration? Has the pendulum swung too far? Can we see a return to people staying in the workforce much longer (to, say, well into their 70s)?

With Minsky's words ringing in my ears - stability creates instability - have decades of retirement stability now sown the seeds of instability?

  1. Government welfare is a pyramid scheme - a greater tax base is required to support the apex. If the apex is bigger than the base, the pyramid topples. Over the past century, the age pension pyramid scheme worked reasonably well. Means testing has helped keep the pyramid upright.
  2. Today's age pensioners (the boomers' parents) generally have lower lifestyle expenses (they are, after all, the children of the Great Depression). Therefore, the age pension, plus modest earnings from their investments, enables them to live within their means.
  3. Life expectancies for previous generations were much lower - they did not stay around for too long at the apex.

These conditions enabled the concept of retirement to become an established, and expected, part of our life cycle...birth, education, work, retirement, and death.

Consider this scenario: If tomorrow the government declared the abolition of the age pension for baby boomers and future generations, how many boomers could afford to retire on their existing capital?

'Very few' would be my response. This indicates that people are either expecting or feel entitled to have their retirement fully, or partly, funded by those who remain in the workforce. Is it fair for younger generations to carry the burden of this growing cost?

Imagine the outcry if this declaration of abolition was made?

This is what a century of conditioning does - what started out in the late 19th century as a sound business practice for a few ('retiring off' aged railway workers for safety reasons) gradually evolved (through the political process) into an entitlement for the masses. What was once a privilege is now considered a right.

So embedded is the entitlement culture that having the temerity to question this right exposes the questioner to wholesale ridicule and scorn.

The standard emotional response is 'I have paid taxes my entire life.'

That was your legal obligation. Those taxes were spent by the government of the day to provide healthcare, roads, national security, education, etc.

Who said you were entitled to receive those taxes back at some stage?

It's just been assumed that this was the social contract.

The reality is that not one cent of those taxes was set aside for the provision of future pensions.

Age pensions are funded annually from the cash flow that the government receives via its tax-revenue collection.

Once you logically dispense with the 'I've paid taxes' response, the next retort is: 'I am entitled to it.'

Why?

'Because I am.'

Not a great argument.

This entitlement thinking has evolved as a result of decades of conditioning.

Don't get me wrong; I'm not anti-age pension - senior members of my family receive an age pension. What I'm doing is debunking the emotionally-charged 'popular thinking'.

Throughout history, the masses get slaughtered - literally and figuratively - because they do not apply critical thinking to situations.

In truth, a retirement that is partly or fully funded by the age pension is a gift...given to recipients courtesy of the efforts of tomorrow's taxpayers. Should the taxpayers of tomorrow decide that the gift is becoming too expensive, it would leave government-funded retirements in jeopardy.

While it's highly unlikely that any government would cease handing out age pensions altogether, a variety of measures will be implemented to restrict the costs from consuming the budget. These measures could include: abolishing indexation, tightening the means test (perhaps to include the family home) and/or raising the eligibility age (again).

Boomer retirees expecting to receive a 'set and forget' level of age pension should think again.

The more indentured tomorrow's taxpayers become, the more at-risk the continuation of the 'entitlement payments' their labour is funding becomes as well.

Please note: This article was first published in The Daily Reckoning Australia on January 09, 2016.

Vern Gowdie is a contributing editor to Money Morning - Australia's biggest circulation daily financial email. Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia. Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession.

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