How to Protect Yourself from the Looming Pension Crisis

By: John_Mauldin

Stephen McBride : Having jumped from one job to another early in life… and with those jobs being across many continents, I haven’t really given much thought to my pension. Looking at the numbers, it seems I’m not the only one. Over 50% of Americans aged 25–34 have no retirement savings. Then again, given the current state of the pension system, it may be a prudent move.

A 2015   from the National Association of State Retirement Administrators estimated that public pension funds are around $1 trillion in the red—but the problem gets worse. 

These estimates are based on funds earning average annual returns of 7.6%. The actual 2015 returns for pension funds came in at 3.2%... a 58% miss. In the same year, America’s largest pension fund, the California Public Employees Retirement System, earned a measly 0.6%. 

If public funds used the same projection method that their private counterparts must, their deficit would be around $3.4 trillion—19% of US GDP. 

At the turn of the millennium, these funds actually had a surplus. So what happened?

Collateral Damage

By design, pension funds should be conservative, low-risk funds, and fund managers should deploy capital into instruments that match these exact criteria (such as AAA-rated sovereign debt).

Historically, pension funds hold around one-third of their capital in high-grade sovereign debt, like . Up until recently, Treasuries ticked all the boxes for pension funds—a low-risk, high-grade instrument, which carries a yield that matches estimated returns. 

However, the 35-year bull market in high-grade sovereign debt is causing severe problems for pension funds. If we take the bellwether 10-year Treasury, its yield has fallen from 16% in 1981, to 2.5% today.

To put that into perspective—to earn the same returns, a fund investing in the 10-year Treasury today has to put in 11 times the amount that it would have had to in 1981. This equates to investing $100 million vs $1.1 billion—a substantial difference. 

Although dwindling yields are a major problem, they’re not the whole story.

While America’s demographics aren’t in as dire shape as , they are still a big problem. Due to the increase in life expectancies and the decline in birth rates, around 14% of the population is now aged 65 or over… a 35% increase in 50 years. In the same time, the old-age dependency ratio has increased by around 50%. 

As a result of these trends, outflows from funds are increasing rapidly. But it’s not just the number of retirees that’s the problem, it’s their life expectancy. On average, Americans born in 2010 will live nine years longer than those born in 1960. With retirees now collecting their pensions for almost 20 years—Bismarck will be turning in his grave.

While outflows are increasing, inflows are plummeting—around 45% of households have no retirement savings whatsoever. This trend has caused many retirees to rely on Social Security, which now makes up around 90% of the bottom quartile’s retirement income.

With conditions set to deteriorate, what will be the implications of a failing pension system?

Inevitable Intervention

Even by government estimates, which suggest public funds are $1 trillion in the red, they are clearly insolvent. We have already witnessed bankruptcies in Detroit and San Bernardino—in which the respective taxpayers of Michigan and California had to come to the rescue. But now the problems are even larger.

Illinois’ state pension fund, which has liabilities of around $18 billion per annum, is only 38% funded and looks set to run out of assets in a few years. Whether this happens in 2017 or 2020, arithmetic tells us something has to give.

Given that millions of public-sector pensions are on the line, you can be sure the federal government will intervene when the problem can no longer be ignored.

Although this will equate to a massive wealth transfer from Millennials to Baby Boomers, this bail-out precedent was set following the financial crisis. The pension system cannot go under, for obvious economic reasons.

While the federal government will almost certainly step in and save the day, those with skin in the game won’t escape unscathed. So, what steps can you take to protect yourself from the looming crisis?

The Golden Nest Egg

 If you are in a public pension scheme, the chances of getting what you have been promised don’t look great—and with little chance of a bailout, the same applies for private schemes. The average funding rate for US corporate pensions is a mere 75%... with private funds having a collective deficit of $500 billion. Also, relying on the average monthly $1,348 Social Security check is risky business.

With underlying conditions for pensions only set to deteriorate, now could be a good time to cut your losses and take your retirement plans into your own hands. So, how do you do it?

The collapse of the pension system will create a lot of uncertainty. One asset that has performed well during times of uncertainty and financial turmoil is gold. The yellow metal had its best January since 2012 and is now up 8% for the year… and the outlook is bright.

Many people thought that gold’s obituary was written in December when the Fed raised interest rates and then laid out a plan to do so three more times in 2017. As gold is a non-yielding asset, the cost of holding it increases as rates rise. But, as we showed this month, rising rates are actually good for gold.

However, the real force that works in favor of the metal is higher inflation expectations. In January, the consumer price index recorded 2.5% year-over-year growth—its highest reading in almost five years. As gold is the ultimate inflation hedge, creeping inflation could be the catalyst that drives the price higher.

The reasons for owning gold go far beyond the current setup. The yellow metal has proven to be a wealth preservation tool for hundreds of years. This makes it the perfect asset to own for those looking to protect and grow their nest egg.

For pension purposes, it’s prudent to own bullion and not gold ETFs or stocks. This is because physical gold is the only financial asset that is not simultaneously somebody else’s liability. When things get shaky, gold ETFs and equities have counterparty risk—physical gold does not.

Given the dire state of both public and private pensions, now is the time for you to take control of your retirement plans. Allocating a portion of your portfolio to physical gold is a great way to start.

How to Get Started

Many financial-planning professionals and prominent investors advise holding anywhere from 5%–15% of your investable assets in gold bullion. The specific allocation depends on factors such as age, risk tolerance, and cash flow considerations.

Until recently, it was challenging to purchase gold bullion in a retirement account and thus allowing for the largest tax advantages. The process was cumbersome and circuitous, involving three separate entities and relationships: a self-directed IRA custodian, an approved storage facility, and a precious metals dealer.

However, new precious metals platforms have revolutionized precious metals and gold IRAs. You no longer need to fill out redundant paperwork, log into multiple accounts, worry about buying the correct products, or finding a buyer for your metals when wanting to sell.

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