A sovereign debt crisis occurs when a country is unable to pay its bills. But this doesn't happen overnight—there are plenty of warning signs, and it usually becomes a crisis when the country's leaders ignore these indicators for political reasons.
Crises occur because countries borrow too much money, which they can't afford to pay back. This is often caused by poor fiscal policy and poor economic conditions (e.g., low tax revenues). A crisis can also be caused by a sudden change in investor sentiment, particularly if investors fear their money will be lost if invested in a specific country.
A common cause of sovereign debt crises is high budget deficits or government overspending. When governments spend more than they take in through taxes and other sources of income, they run up deficits that must be paid back through future tax receipts or borrowing from abroad (e.g., from bondholders). This creates an unsustainable situation where the government's obligations exceed its ability to pay them back.
When this happens, investors stop lending money to the government because they don't see any good reason for them to do so—they're worried about getting their money back with interest on time or at all!
At what point does the US face a sovereign debt crisis? The question is difficult to answer; however, numerous economists have stated that trillion-dollar annual deficits could become the point of no return. At this point, our interest cost to the US government (taxpayers) will exceed the federal budget for all defense spending.
As of this post, we are now running a $2.2 Trillion deficit.
One trillion is a lot, so here is a frame of reference.
Three numbers sum it up:
26% is the combined increase with inflation and population over the last ten years
35% increase in revenue (so we don’t have a revenue problem)
49% is the increase in spending over the same period
The sad part, these numbers were current from 2008 to 2018. With current spending, the results are much worse.
If you think about what our country will need money for in the future, it’s clear that tax rates have to increase. We have Social Security, Medicare, and Medicaid; for now, let’s just focus on Social Security.
When social security started in 1935, we had 42 workers for every person receiving benefits. In 1935, you had to be 65 to claim social security, but the average life expectancy was 62, highlighting that the government weighted things in their favor.
If we fast forward to today, you have 2.7 workers contributing for every one person receiving benefits. Social security started as a way of protecting people from living too long. Today, it’s a benefit that provides income for people for nearly a quarter of their lives; it has become a pension program, which wasn’t the original idea.
Everyone seems to believe that 10,000 baby boomers are retiring each day, which is only an average (it’s not true). The number one birth year for baby boomers was 1957, followed each year closely until 1964. This means that 70% of the baby boomers will retire between 2022 and 2029, and we don’t have the money now to cover the current benefits of retirees receiving social security.
David M. Walker, the former US Comptroller General (1998 to 2008), highlights in the documentary “The Power of Zero” that “Social Security was last reformed in 1983, which was a real accomplishment. The truth is that many people don’t understand that the reason we had Social Security Reform in 1983 was because the so-called Trust Funds were going to go dry within a matter of months. If the Trust fund goes dry, this means the government couldn’t pay benefits in a timely manner.”
Every year the government does nothing, the problem becomes more challenging to correct. While I didn’t go into Medicare or Medicaid, those programs only worsened a very problematic situation. Just to highlight how bad, in the next 75 years, Medicare spending alone is projected to take up the entire Federal budget.
It’s no secret that tax rates have to go up. When? I’m not sure. Our elected officials are playing musical chairs, and the party in power will have to make a decision when the music stops.
Ideally, you want a more significant percentage of your future income (or retirement dollars) to be tax-free. There are three options for generating tax-free income in retirement.
A Roth IRA is a retirement account that can be funded with after-tax dollars, but any growth and withdrawals are tax-free in retirement.
Other advantages of having a Roth IRA include:
No contribution age restrictions. You can contribute at any age if you have qualifying earned income.
No Required Minimum Distributions (RMDs). There are no mandatory withdrawals, allowing your savings to continue to grow even during retirement.
A Roth IRA can be a good savings option for those who expect to be in a higher tax bracket in the future, making tax-free withdrawals even more advantageous.
We love Roths, but they have contribution limits and income restrictions. You can do a backdoor Roth IRA by re-classifying IRA dollars to a Roth IRA if your income prevents you from contributing directly.
A Roth IRA is a fantastic savings option if you believe tax rates will increase or your income will push you into a higher tax bracket. Make sure you have a great investment strategy to complement the tax benefits given to these accounts.
Focused Investing is a great way to maximize your Roth's growth potential.
These aren't accounts but tax-free investments.
Municipal Bonds are a bond issued by local government entities, like State governments. The investment income generated by the bond is free from Federal tax and often free from state and local taxes to the investor.
Are they good investments?
Short-term, maybe.
Long-term, maybe.
Most municipalities aren’t any better at controlling their budgets than the Federal government, and the Federal government subsidizes a majority.
Cash value life insurance is designed to accumulate tax-deferred, and income can be tax-free if taken correctly. Life insurance has received preferred tax treatment since the beginning of time because the primary use has always been death benefit protection; however, using life insurance for tax-free income is not new either. The issue comes down to your chosen product, design, carrier, and advisor.
We utilize indexed universal life for several reasons. More importantly, the strategy we use incorporates bank financing.
The strategy utilizes a safe form of leverage, similar to a home mortgage. A key difference is you don’t need to qualify for the loan because the bank isn’t underwriting you; they are underwriting the insurance carrier. Our lenders match your contributions up to three-to-one (or 300%). The goal of the strategy is to bring more capital to a conservative asset class and increase your income by 60 to 100%.
To learn more about the strategy, you can watch a 20-minute demo of the strategy.
In the end, you'll likely want to consider two of these options as tools in your retirement income portfolio. Each option has its own pros and cons, but each also offers a similar benefit: tax-free growth in future retirement income. In that way, each one is a winner—but it may just come down to what's more flexible for your unique goals and situation.