How Government Debt Affects Retirement

The Baltimore CFA Society hosts monthly seminars on various topics.  The most recent seminar was titled “Going for Broke- How Government Debt Affects Retirement”.  The presenter was Michael Tanner.  Mr. Tanner is a Senior Fellow at the Cato Institute where he heads research into a variety of domestic policies.

Since the federal deficit is an issue that frequently appears in the headlines, I thought it best to summarize and offer my opinion on how this affects financial planning and wealth management.

Let’s discuss why excessive debt is dangerous.  When debt is issued, that debt has to be serviced by paying interest. Interest payments don’t buy you anything. For example, this is money that isn’t being invested in infrastructure or in an entitlement program, such as Medicare. Michael Tanner noted that “Interest payments are the fastest rising portion of the federal budget.” Additionally, if a country has too much debt, eventually interest rates will have to increase to incentivize others to lend the government capital.  This, in turn, further increases interest payments.

Another problem with too much government debt is that private borrowing gets crowded out. For example, if the government issues a tremendous amount of debt, that competes with corporations who are also issuing debt with the intention of investing in their business.  Corporations now have to increase the yield on their debt in order to raise capital.  This makes it more difficult for companies to grow.

*The national debt currently stands at 19.5 trillion dollars, which is 104% of Gross Domestic Product (“GDP”).  To put this in perspective, Japan has debt that is 229% of GDP, but most countries are below 104%.  However, these figures don’t include implicit debt such as unfunded liabilities, including Social Security or Medicare.  If implicit debt was added to the 19.5 trillion figure, the total debt would be approximately $100 trillion.

Approximately 50% of federal spending is dedicated towards entitlement programs such as Social Security, Medicare, and Medicaid. The national debt issue has become a partisan issue.  Mr. Tanner stated that the solutions from either party in many instances won’t address the spending problem.

For example, increasing taxes on the wealthiest 1% will barely move the needle in terms of paying down the deficit.  On the other hand, cutting foreign aid spending or defunding social programs won’t have much of an effect either. The only way to deal with the budget is to address Social security, Medicare and Medicaid. Let’s look at each issue.

Social Security’s challenges primarily revolve around demographics.  People are living longer (which is a good thing), but this is a challenge from a budgeting perspective. In 1950, there were 16 workers for every retiree. Today, there are only three workers for every retiree. This means less people are contributing towards social security and people are receiving benefits since they’re living longer.

For Medicare, the average couple will pay $140,000 in Medicare pay roll taxes throughout their life and will collect $422,000 in benefits.  Not only are demographics an issue pertaining to Medicare, but so is inflation.  In 1975, a person used $2,000 of Medicare benefits.  Today, the annual amount is $12,000, and in 2025 it’s projected to be $20,000.

Medicaid was designed as a welfare program to benefit the poor.  However, today a large percentage of the Medicaid budget is spent on long term care for the elderly in nursing homes.  Many of these Medicaid recipients are in the middle class but have found ways to qualify for Medicaid so that their nursing home costs will be paid by the government.


Mr. Tanner stated there’s “not an easy solution”, and “no painless way to deal with the budget, but we can’t do nothing”.  He proposed the following solutions, such as adjusting Social Security benefits at a lower rate while making an exception for people who have lower income levels.  He also said people using Medicare simply need to receive less benefits.

While these steps seem somewhat logical as a starting point, Michael Tanner said the issue is that people who receive benefits from these programs make up a large percentage of the voters.  Therefore, it’s very difficult to make progress in this area.  Politicians who understand America is probably in too much debt and want to minimize spending on entitlements are regularly attacked.  Michael Tanner said while you would think this happens more on the Democratic side, it also occurs among conservatives. For example, currently Donald Trump, the Republican nominee for President, is opposed to any cuts in Social Security or Medicare benefits.

My take

While there are certainly issues with the federal budget, and disagreements on how to solve these problems, it appears that there are ways to get them solved provided politicians are willing to  work together.  Also, there’s no way to know when this issue will affect the economy.  The sooner there’s a plan to tackle these issues, the better and less painful it will be.

How does this relate to people’s investments?

People who are accumulating wealth and not yet retired (people in their 40’s and below) are going to have to save more money for retirement and health care costs.  While Social Security, Medicare, or Medicaid may exist, they shouldn’t be relied on to provide the same benefits as retirees are currently receiving.

To expand on the concept of saving, people shouldn’t simply save in cash or cash equivalents since the returns may not outpace inflation.  It’s important to build a diversified portfolio of cash, bonds, stocks, and alternative investments.  This can help you pursue portfolio growth over a long time horizon.

It will be critical to rebalance the portfolio and adjust the allocation to a more conservative one as you approach retirement. From my experience, people tend to be very emotional when it comes to investing their own money.  Emotion can cause an investor to panic and make poor decisions.  Therefore, it’s probably best to partner with a financial advisor who can help you plan for the future, with the intention of keeping you on track and reaching your goals.  (If unsure how to choose who to work with, feel free to read a newsletter I wrote several months ago titled “How to Choose a Wealth Manager


Thank you,

Philip B. Snyder, CFA

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
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