Few of us have ever experienced anything like the turmoil and upheaval of the last two years. We’re all feeling the impacts of longevity, inflation, taxes, and frustrating decisions by our government. This means it’s a great time to welcome today’s guest back to the podcast.
Larry Kotlikoff brings 35 years of experience to our industry and on January 4th, he’ll be releasing Money Magic: An Economist’s Secrets to More Money, Less Risk, and a Better Life, where he digs deep into what people do wrong–and how to fix those mistakes for good.
In today’s episode, Larry shares some of the over 50 shocking money stories that are detailed in his new book, the complexities, and challenges of Social Security, and the tools you can use to stay in the best financial shape possible no matter your situation.
In this podcast interview, you’ll learn:
Andrew Rafal: And welcome back to a brand-new episode of Your Wealth & Beyond. Professor Kotlikoff, welcome back to the show. How are you today?
Larry Kotlikoff: Good. Great to be back with you, Andrew, yeah.
Andrew Rafal: A couple of years flies by, and they always say this time it’s different, but it’s definitely been from the standpoint of tumultuous times, the last two years has been one that in my lifetime, I’d really never seen. And I know you’ve seen some cycles but just blows us away of what the news has been.
Larry Kotlikoff: Yeah, it’s really, and all these illnesses and deaths and anxiety, it just is really terrible times, no question, and it’s just ongoing. And I felt for everybody who’s lost people or has gotten sick from this.
Andrew Rafal: And every time we feel like we’re getting back to some normalcy, it’s like, boom, something else happens. So, we have to take it day by day. And I know over the last year or so, you’ve been really busy, and that’s exciting stuff going on with your end. So, we’ll dig into, I think, it’s going to be your 20th book that’s coming out here in January.
Larry Kotlikoff: Yeah, January 4th. It’s called Money Magic: An Economist’s Secrets to More Money, Less Risk, and a Better Life. So, it’s basically everything I’ve learned in my 35 years of working on personal finance.
Andrew Rafal: And today, we’re going to try to talk some high level on what’s in the book and some of the things that we’ve utilized with our clients and some of the core beliefs you have, which is helping to reduce risks of longevity, inflation. Now, obviously, taxes are a big thing, but look, your whole career has been spent in the world of helping people make smart decisions, digging deeper analytically, looking at what the government can potentially do or what they are doing wrong. But when we think about the last 30-plus years when you were growing up as a young boy and becoming into your college years, and so, did you always know that this is your passion, that numbers and the economy and really helping people? Where did that come from?
Larry Kotlikoff: It came from a frog, actually. I discussed this in the intro to Money Magic, I was intending to be a doctor so I had to take biology. And in biology, you have to dissect frogs. And in this case, I had to kill the frog, kind of give it for something on its heart, do open heart surgery, put some chemical, and it’s hard to stop the heart and then rub the heart and resuscitate it. And I didn’t have to do this once, I had to do this like 30 times in the lab. So, the instructor came over and said, “Great, now do it again.” And then, it was always like, “Great, kill that frog again and revive it.”
And at the end of that class, I was an economist. I had switched majors. I decided I was enjoying my economics course. And I knew nothing about economics, I just accidentally took this course, I had a great professor. And it was from that point on, I was like, sold on economics.
Andrew Rafal: Beautiful.
Larry Kotlikoff: Yeah, that’s right.
Andrew Rafal: And I think from going back to my year, I did not like that as well in high school, having to go through on the biology and things of that nature. So, on that end, why do you think we don’t teach financial planning, budgeting, these things in high school, or even making a prerequisite in college for everybody? It’s just like it blows my mind that this isn’t built into the system.
Larry Kotlikoff: I’ve developed, as you know, this financial planning software called MaxiFi.com, M-A-X-I-F-I dot com. And we’re now on our 29th year, well, 28th, it will surely be 29th year that we’ve been running the company and the software is very simple. You put in resources, earnings, assets, things about retirement accounts, Social Security. That’s about it. And then the program cranks, and it says, “Okay, here’s your sustainable living standard.” And it’s a simple tool that a high school kid could use. And I have approached high school teachers and said, “Look, we give this to you for free. Run it with your math class.” This thing is based on math. The lifetime budget has to add up. You can’t spend more than you have in resources. And the first thing you see when you run the program is a lifetime budget. Here’s the present value of all the resources, the wealth.
So, it’s pretty benefits of withdrawals from your retirement accounts, the labor income, and so on, present value. Here’s the present value of the off-the-top expenses, the taxes, the housing expenses, and the discretionary spending is what you get is the fund money. That’s what we’re solving for. And the program is just trying to smooth that out per year so that people’s living standards don’t fall off the cliff. They can maintain their living standard per household member. That’s completely simple. Any high school kid in a regular math class with a little help of a professor could learn this in 10 seconds. And then they’d have a tool they could use the rest of their life. So, I’ve been pushing this with high school teachers, but they don’t go for it for some reason.
Andrew Rafal: Why do you think that, is it just for them making a change or bringing something new is a risk that may in their mind go the wrong way?
Larry Kotlikoff: I think they have a set curriculum and they don’t want to necessarily go the extra mile, but this is like a fun thing to do with the kids. And so, if you’re a parent who wants to teach their kids some basics about financial planning, grab this software and work it out with their kid. They’ll probably end up teaching you how to run the program. It takes 20 minutes to input your results, look at the results, and understand what it’s doing. We have all kinds of videos. It’s very simple.
And the book Money Magic is predicated on the things I’ve learned from running the software, not exclusively, and it’s not a user guide to the software. I don’t even really mention the software. The editor said, “You really can’t talk about the software.” I mentioned it in the preface, I mentioned at the very end, like in a couple of sentences because what I know is that most people don’t want to run software to play in their lives. They want to talk to a professional like you or they just want to read about what to do. And that’s what I said. Basically, I said I can explain to people from everything I know from running the program, but just in general about all kinds of topics like divorce, for example, I talk about divorce, I talk about marrying for money, I talk about shacking up with mom. Lots of topics are not exactly covered by the software and the book.
So, the book is meant to shock people. It’s got probably 50 really strong financial shockers in there, as you get older in retirement, should you be investing more in stock out of your financial assets? It turns out that’s a standard result in economics of finance. Nobody would think that as you get older, you should be investing more and more heavily in stock. Why would that be? The reason is that you’re trying to maintain a balanced portfolio. So, as you get older, your assets, your total assets, your regular assets, your brokerage account, you’re spending it down, but your Social Security benefits are not declining, right? So, you’re becoming more of your total assets. Resources are invested in things like– Social Security is basically a bond. It’s a stream, that’s for sure. It’s a real bond because it’s inflation indexed.
So, through time as you’re working down your assets, as you’re spending down your assets, your brokerage account, you’re becoming more and more invested in bonds. So, to maintain a balance, you want to take that smaller amount of your brokerage account and put more of it into stock because that maintains more of a stock-to-bond ratio, more of a constant ratio by doing that. So, it’s the share that should be invested more in stock. The absolute amount is not necessarily going up, it’s going down, but the share goes up.
Andrew Rafal: And if that kind of puts everything on its head there, we look at the whole mantra is as we get closer to retirement. And then in retirement, it’s less than the amount of risk that you have in the portfolio. So, what would you say to somebody on that end, especially we can never time the markets, but we’ve had a 10, 12-year run, we know we’re at some point going to see a market correction of risk assets, whatever the reason may be, and not just as short-lived as we saw last March and April. So, what would you say to somebody there who would– the typical financial planning side of it, which is let’s lessen some of the risks?
Larry Kotlikoff: Yeah. Well, I’d say on the timing, you just say we shouldn’t time the market, and one of the financial shockers in the book is that it says that we should time the market. And what I say in the book is that we should time the market not for return because the market is evolving as a random walk. The return on stocks is based on new news that comes in. If people knew something, they would already have used that in investing, and the stock price would already reflect that information. So, it’s only new information, which by definition, if something is new, you can’t predict it, it’s unpredictable. So, that’s why stock returns evolve as a random walk.
And I try and make that clear because there was a book written by Burton Malkiel about A Random Walk Down Wall Street. I looked at Burt’s book, and I didn’t think it really fully explained why stocks should evolve as a random walk. And that’s the basis for people saying you can’t time the market because you don’t know what’s going to happen. You can’t say, well, the stocks are low, and therefore, they’re going to go back up because that’s not connected with a random walk. Random walks is that they’re low, they could be lower tomorrow. There’s nothing that says they’re going to go back up. Stocks are not safe in the long run. That’s another financial shocker, really, relative to received wisdom.
But why should we time the market? Why am I saying we should time the market if I’m also saying that stocks are evolving as a random walk? It’s because we should be timing the market for risks. Risk is not constant through time, and as things get riskier as COVID, for example, we now have this Omicron, or whatever it’s called, variant. And you know the market is dropping, people are pulling out. So, they are timing the market and they’re doing it properly because the environment is riskier. We don’t know what this thing is going to mean.
Things are riskier, and since we’re a risk averse, averse to risk, we don’t want to hold as much in risky assets when things are riskier, when times are riskier. So, we should time the market not for return but for risks. So, that’s another one of these kind of financial shockers. There’s 50 of them in the book, if I just tell you, you should time the market, I’m an economist and I work in finance as well as personal finance, and you might say, “Well, this guy’s nuts.” Finance is not the time to market, and it does. It says don’t time the market for return, but it does say time the market for risks. And this is something that economists have not pushed with the public.
So, one of the guys endorsing the book is Bob Merton. He’s got a blurb that says fantastic things about the book. Now, Bob Merton is like the Isaac Newton of finance. He’s got a Nobel Prize for his work in finance. So, having Robert Merton endorsed the book is like having the economic gods bless the book. It doesn’t get better than that. So, he read through it very carefully. He blessed everything I wrote. So, I’m saying things are consistent with what the top finance economists in the world are thinking or saying in their work.
Andrew Rafal: And before we jump into more of the topics that I think a lot of our listeners are interested in and some of your core beliefs on Social Security and how complex it is but some of the strategies we should look at while I have you on, I’d be remiss that we don’t talk a little bit about where we are economically, right? The inflation fears, supply chain, the money supply, things that you’ve been talking about, and I think this, four times, 10 times over the last 18 months. So, thought process there, we’re seeing inflation obviously hitting a lot of different factors, dinners, travel, the big ones that a lot of us face. Where do you see things going right now with the money supply and inflation? And are we going to be able to wrap our heads around this? Or is there going to be something, like the 70s where we have stagflation, where my generation hasn’t dealt with that before?
Larry Kotlikoff: Yeah. Well, there was this economist named Milton Friedman, I don’t know if that name rings a bell. He got the Nobel Prize and he was of the view that if you look at the government’s printing of money, what’s called is base money, there’s a relationship through time between the price level and the amount of money that’s been printed. But what Friedman, I think, missed is that a lot of the printing of money that the Fed is engaged in, and it’s increased the base– it’s called the base money, the base money supply by a factor of six since 2008. We’ve got six times more money having been printed now than we had in 2008.
But a lot of what that increase in the base money is about is the Fed will go buy a security. So, maybe, they’ll go print money up, and it might buy, just for an example, General Motors stock, maybe it’s trying it, or a bond, not so much stock because the Fed is not investing really in stock but bonds. I mean, sometimes it does invest in stock but mostly, it’s bonds. So, it buys that General Motors bonds. And then it might say, well, you know what? Somebody would say, well, that’s inflationary, print out more green dollar bills, and bought up these certificates, but the Fed might say in response, well, look, in two years, what we’re going to do is take those shares of stock and sell them into the market and pull the dollar bills out from the economy. So, we’re not actually through time, increasing the total stock of money. We’re temporarily increasing the stock of money but not through time.
Why am I telling you this? I’m saying this is because we don’t know for sure if the Fed will do that, will be able to reverse the printing of money. So, we can’t say how much the Fed’s behavior is inflationary or not. What we do know from looking at other countries like Argentina, the 22 countries around hyperinflations in the last century, is that countries that are fiscally insolvent are in trouble, fiscally speaking, have a long-term trajectory of projected spending that is much larger than their projection of receipts of taxes. If they look like they’re in fiscal trouble like our country does, our country looks in terrible fiscal shape long term, if you look at the difference between the projected outflow and the projected revenues, it’s about 8% of GDP every year forever. It’s enormous.
And most of the liabilities, obligations are off the books, like my Social Security benefits that I’m now receiving since I’m over 70, that’s an obligation that your generation and your kids, my kids have to pay. That’s not on the books as an official debt. So, if you say, let’s put everything on the books, whether or not it’s called official or unofficial, put it on the books. It’s 8% of GDP forever that we’re short. Countries that are short that kind of amount of money tend to print money to pay these bills to make up the difference. They tend to generate inflation. So, I can’t say for sure that the Fed’s behavior is really trying to print money to pay for Uncle Sam’s bills.
But every other country that’s in this kind of fiscal shape, historically, the first thing they do is they put pressure on the Central Bank to print money to deal with not raising taxes. So, I do think that we have a long-term inflation problem, enormous one. And I do think that people should be very wary of buying long-term bonds because they’re yielding a return that’s predicated on the assumption that inflation is going to be 2.25% as of today’s market, roughly. And that’s just nuts. I mean, we’re running 6% inflation right now. Why should it go back to 2.25% when the country is so broke? I mean, we’ve got members of Congress who don’t have an iota of background in economics, and they just want to get themselves reelected. We’ve seen the political nature of their decision-making.
So, some presidents are going to come along and grab a compliant Federal Reserve chairman who will not buy bonds and orders, or to temporarily hold bonds and then sell the bonds back in the market and withdraw all the money and keep the money supply over time, something stable, but rather the Treasury will print bonds in order to get some money to buy gas for Air Force One. And then the bonds that they sold into the market, the Treasury bonds, the Fed will buy, and if you put it all together, we’ll just have the Fed printing money to buy the airplane fuel for Air Force One. And that will be kind of the way it goes.
So, now, because things are complicated, and we don’t know how the Feds are going to behave through time, the public has to kind of guess what inflation is going to be. And then they’re guessing can be, we think it’s going to be very high. So, expectations can play a huge role here. Right now, we’re seeing 6% inflation. The market’s expecting 2.25% inflation in terms of the returns long term. But those expectations could turn on a dime, and people could start to really realize how broke the country is and how much money will likely be printed to pay for the Air Force One fuel. And that could lead to everybody expecting 6% inflation for the long term.
In that case, if you’re holding bonds or yielding 2.2%, you’re going to take a huge loss. So, I’d be very careful about inflation, very careful about holding bonds. I’d be very concerned about, if I have a pension, for example, that’s nominal that’s not inflation indexed, an annuity that’s not inflation indexed, I’d be very concerned that inflation is going to water down my income through time. And we have a lot of people still on pensions that are nominal, like Detroit firemen and women who got a bad settlement as a result of Detroit going broke. Well, they got a nominal pension. They got like 40 cents on the dollar if I got it right, and it’s fixed nominal terms. Well, if inflation is 6% for five years, they’re going to be wiped out.
So, how can you protect yourself? One of the things I talk about in the book is if you take out a bigger mortgage since rates are still low, you’ll be able to pay back the mortgage and water down dollars if inflation takes off. So, a mortgage can be a natural hedge against inflation. Any nominal liability that you have to pay off, if the interest rate is not too high, it might be a good inflation hedge.
Andrew Rafal: Yeah. And we have those conversations with clients all the time, do we pay off the mortgage? And then, right now, some people are sitting at 2.5%. So, yes, psychological, I have no debt, but we explained if you’re house rich and cash poor, and that cash which has ultimately risks, in theory, yes, there’s no risk, but there’s inflation risks, etc., opportunity cost, but if they can make 6% in the money market. So, those are the type of conversations that I think everyone needs to have. Now, if they’re sitting at a 6% mortgage, you can do the math. And of course, it makes sense to work to pay it down.
The one thing you mentioned with the debt and the GDP, at some point, like the 10-year treasury now with it being at 1.42 right now, and it’s been fluctuating, but at some point, it has to give, yes, the Fed can keep rates low, but at some point that is when we look at treasuries, people don’t realize it is a very volatile asset. And if you look at it historically, it’s sometimes more volatile than even equities when you look at the volatility that can be there. So, do you think that that’s going to be something that we’re not really bringing into the equation now because obviously, the government’s refinancing pretty cheap, just like we are in our housing, but what happens if that turns that the market says, you know what? We need more for the risks we’re taking.
Larry Kotlikoff: Yeah. And I think everybody should demand more, and therefore, stay away from 10-year bonds, stay away from, for sure, 30-year treasuries because people are not aware, Andrew, of how broke the country is fiscally. I mean, it all comes back to that. Ultimately, if you can pay for what the government is spending by using taxes, then you don’t have to print money to pay for the government’s bills. The Social Security Trustees Report came out a couple of weeks ago, maybe it was a couple of months at this point, where it’s showing a $59 trillion unfunded liability. The official debt is $22 trillion.
Think about this. The trustees of Social Security have a report in Table VI.F1 tucked away in the back of the appendix of this annual trustees report. They don’t talk about it. The trustees don’t mention it at all at the beginning of the report and talking about the condition of Social Security, its financial condition. But then if you look at its long-term unfunded liability, this is the present value of all the outlays projected by the actuaries of Social Security versus the present value of all the tax receipts that are going to come in, $59 trillion short, that’s two and a half years of GDP. That’s just Social Security. You add that to the official debt, which is one year’s GDP. Now, we’re talking about three and a half years of GDP.
Well, Italy’s official debt is about one and a half years, two years of GDP, the official debt, so that’s much higher than our official debt, which is one year of GDP. But their unofficial debt is much smaller. So, Italy actually is in better long-term fiscal shape than we are. I say that we’re short about 8% of GDP forever. And just to be clear, Social Security benefits are roughly about 5% of GDP, 4.5%. So, we’re talking about one and a half, two Social Security programs. That’s how big 8% of GDP is. So, it’s not a small thing.
Italy, they’re short about 1.5% of GDP. So, the same calculation has been made for the European Union members and for the US, but in the European Union, the government actually, the European Council actually does it. In the US, I do it. So, I’m the only one, probably in the country, well, there’s a couple of other economists, Alan Auerbach at Berkeley, for example, also does these kinds of calculations, sometimes with me, sometimes with other colleagues at Brookings. But there’s only a handful of people that are focused on our fiscal gap, and it’s enormous.
So, yeah, we’ve got to be really careful about inflation. Otherwise, the economy has done much better than I would have expected given COVID. We have adapted very well. The Fed has come into kind of rescue the market, but if inflation does take off, which if everybody in the country were to listen to this podcast, I think, the 10-year rate would change this in 10 seconds when the markets open today.
Andrew Rafal: Well, that’s a lot of pressure you’re putting on my– but no, this isn’t depressing talk, it’s reality, right? It’s what’s kind of not brought out to the attention of the masses. A lot of people don’t understand it. But what would you do to fix it? Is it fixable, right? Because what you’re telling us is a very difficult story to comprehend. And it’s like in some people’s mind, does that mean the end of our empire, is it upon us? A lot of people don’t know this, but in 2012, in 2016, you did run for the presidency. What is it that you think can be done to salvage where we are today for the next generation and the next generation?
Larry Kotlikoff: Just to be clear, I ran as a write-in candidate and I was running, particularly in 2016, in order to explain what economists think we should do. So, I thought, gee, I’ll write a platform, and the press will take my views, which were really the views of most economists because I was trying to ask economists what they would do before I wrote my platform. So, I talked to tons of people in my field. So, I wrote this platform, and then once Trump was elected, I turned it into a book called You’re Hired, not you’re fired, but you’re hired. And it’s on my website at Kotlikoff.Net, and anybody can download it for free.
So, it says exactly what I would do, how I would fix Social Security. What I would do would be, look, the thing is broke. When all these corporate pension funds were broke, what do they do? They froze them, they paid off what they owed, and they set up defined contribution plans. So, they got out of the defined benefits business and went into the defined contribution system. So, that’s what I’m proposing for Social Security. How would I fix healthcare? I would put everybody into Medicare Part C, which is the version of Medicare that the Republicans have developed, which involves competition between you get a voucher to join a health care plan, and the size of the voucher, which is basically your ticket to get into that plan that you give to that health insurance company that you’re going to choose every year.
It’s bigger if you’ve got diabetes. It’s based on your preexisting conditions so that the healthcare company is not going to be interested in discriminating against you because they know that if you’re sick, they can make money on you because you’re bringing them a bigger premium, and it’s being paid for by the government. The government is going to evaluate you based on your preexisting conditions, give you a voucher. If you’ve got diabetes, you might get the vouchers twice as big as somebody who doesn’t. So, the insurance companies will immediately see that they can make money off of everybody. And this eliminates immediately the problem of cherry-picking, which has plagued this industry from the beginning. That’s the key problem.
So, as economists, we have been studying why the health insurance market doesn’t work like the apple market or the wheat market. It’s cherry-picking. And it’s because the insurance company doesn’t know if I’ve got diabetes, necessarily, but if we make this information public and we compensate people with bad information with a bigger voucher, now, you’ve got everybody on an even playing field. Now, we’ve got the health insurance market transformed into the wheat market. We can have incredible competition. We can have health insurance for all. So, we can get what Bernie Sanders runs efficiently with competition and get our country from paying 18% of GDP on health care down to about 15%, 12%, somewhere in there, like the Europeans are paying. Twelve percent is what the Swiss, the French, the Germans are paying out of GDP, not 18%. That’s driving us broke.
So, unless we get that fixed, if we can bring that from 18% down to 12%, that’s 6 percentage points of the 8-percentage point problem that we’ve got, right? And fixing Social Security is going to save a bunch of money. And what else can we fix? Well, we can fix the banking system in a manner so that we never have another 2008. I mean, I try to discuss how to fix the tax system. So, we actually get the rich to pay their– the super-rich pay no taxes. They’ve got their assets in stocks, and things are appreciating. They never sell things because they don’t want to pay capital gains taxes. They just borrow at low rates to pay for their yachts and everything else.
And then they leave their appreciated assets to their kids with what’s called a step-up in basis, you know all about that. So, the kids don’t have to pay tax. That capital gains tax is being avoided. So, this is terrible. What we should be doing is taxing the consumption of rich people, it’s very easy to do this kind of a calculation to introduce a progressive, what I call cash flow consumption tax. So, I think, straightforward tax– well, it’s straightforward. Every one of the proposals has got like 10 bullets, that’s it, okay? Very, very, simple, how to fix banking, Social Security, education, health care, taxes. And so, people should, if they’re interested in policy, download You’re Hired!
Andrew Rafal: And we’ll have it in the show notes, listeners. So, we talked on Social Security, right? It’s in trouble, that $59 trillion, that number, that’s just gas, you can’t even fathom it. So, then we know it’s in trouble, and you’re a big firm believer. And over the years, I’ve used this book to get my team well versed because we do believe Social Security is that core piece of that foundational in a sense of guaranteed income. So, you’ve always been a believer, and we’ll talk about this now in regards to how do we utilize those that are taking or close to getting their benefit? What’s the best means to do it?
And obviously, you’ve spent many years helping through your different contributions with Forbes and PBS and your book and just having people understand that, yes, this is very complex. It’s more complex than you said in the tax code. But before we jump into your thoughts as to how to utilize it the best way, and we get this a lot, well, if it’s not going to be there, why shouldn’t I take it then at 62? We know that that’s a very bad financial mistake when we look at using your software or so forth. But what can we tell somebody then, if we’re saying that this system is broken, well, then why should we push to have them delay as long as possible?
Larry Kotlikoff: Okay, so a couple of things, I want to be clear is that, I have these proposals for how to fix Social Security, but when it comes to actually advising people in my book Money Magic or in the book Get What’s Yours that I coauthored with two buddies, I’m trying to say, look, I’m not president, I’m not going to be president, I don’t think. Maybe I didn’t win because I was too young, could be. Maybe next time around, if I run, I get elected, I’ll be at the right age or closer to the right age to become president these days. But when it comes to actually advising or suggesting the people what they should do, we have to look at the reality of the politics, our political system. And I don’t think that members of Congress will ever cut Social Security benefits directly. I think what they’re going to do is tax them at a higher rate, which is going to differentially affect richer people. And I think they will perhaps use general revenues, come up with other ways to pay benefits to cover the shortfall.
But even if they did cut Social Security benefits, let’s say, by 25% starting in 2031 when the system’s cash flows go negative, which I think is just politically suicidal, so I don’t think that’s going to happen. But even if they did, it would still be people that wait until 70 to take their retirement benefit because their benefit is going to be cut either way. If they take the benefit early at 62, it’s still going to be cut in the future. And if they take it at 70, it’s going to be cut in the future. So, the gain from waiting will be smaller, but it’ll still be enormous. It’s astronomical right now for most people. I’m not saying that everybody should wait until 70.
Obviously, if you’re single and your maximum age of life is, you have prostate cancer, you’re only going to possibly live for a couple of years, you should take your benefit right away. But if you’re, let’s say, 68 and have prostate cancer and you have a spouse and maybe a couple of ex-spouses who are going to collect widow’s benefits on you, you want to wait because you’ll be able to raise their survivor benefits and whatever’s benefits by 16%. So, it is very much dependent on your circumstance, and you need to know what’s in that book. But in my Magic, I point out, kind of I have 10 secrets to getting the most Social Security benefits. I reduce that whole book to one chapter, 10 secrets, to get the most important things across to people like they should not get scammed by Social Security.
Social Security is running several different kinds of scams. They’re scamming widows of getting them to lose lifetime benefits. Their inspector general came out and said that Social Security has scammed in recent years 13,000 widows to the tune of $130 million, and at least under Trump, this was not addressed. Now, I don’t know whether under Biden, Social Security will go back and fix this, but the inspector general of Social Security said Social Security needs to go back and look at all the cases where they scam people. And I could explain the scam if you want, but…
Andrew Rafal: Is the scam just in regards to not fully educating them about how the widow benefit works and how they could potentially take their benefit and delay the widow benefit or vice versa, it’s just more of hey, take your widow benefit at 60, and then they’re stuck with that lower amount?
Larry Kotlikoff: Well, it’s quite a little bit different. It’s more like, people are 62 who just became widowed, and they had them take both their widow and their retirement benefits at the same time, which they didn’t have to do. And consequently, they weren’t able to just take their widow’s benefit, and then let their retirement benefit grow by 76% to age 70, and then switch from their widow’s benefit at 70 to their retirement benefit, which would have been 76% higher. So, imagine your retirement benefit is just a dollar below your widow’s benefit, your early retirement benefit at age 62 is a dollar below your widow’s benefit available at age 62.
So, what Social Security did has had them check off the box to take both benefits, and they just got their widow’s benefit for the rest of their lives instead of not checking off that box and that form and wait until 70, and then having their benefit, their check basically go up by 76% for the rest of their life from 70 to 100. So, that’s a scam. There’s a couple of scams that they’re running, and they’re discussed in this book, Money Magic. You got to avoid them because this is a dishonest agency basically. I’ve been writing about this. I’ve been using the word scam in Forbes in columns, and it’s not being addressed by members of Congress. So, we just have to be careful on our own to make sure we don’t fall into this trap.
Andrew Rafal: Yeah, we see it even in our industry, in financial planners and CPAs, they don’t really understand the rules and they’re not guiding their clients into making those good decisions. And we look at it as the amount of money that was put into the system and the amount that they should, based on a normal life expectancy. How much they’ll be getting back out is not a decision that should take 15 minutes, which a lot of people do. And on your point, using software like yours, we’ve gone with clients and said, “This is the strategy based on X, Y, and Z.” And they’ll go into the Social Security Department when you could before COVID. And literally, they’d have to call us because they were told, no, they couldn’t do this, and we had to actually get a manager type of individual to walk through this and say, “No, this is the rules.” So, if that’s happening, when we’re giving the guidance, imagine when they don’t have somebody that’s helping them through or reading your book or your contributions, it’s pretty scary.
Larry Kotlikoff: Yeah, you do not want to ask Social Security any questions because at least half the time, they will tell you something that’s 100% wrong, that’s incomplete or misleading, and that will lead you down the wrong path. Or without your consent, they will check that box, for example, if you’re a widow, some of these cases, these 13,000 cases where some staff, they didn’t know what they were doing, they check the box for the person and say, “Well, surely, you want to apply for all your benefits right now that are available.” No, you don’t want to apply for all your benefits that are available. You absolutely don’t. You want to apply for one or the other but not both at the same time. So, yeah, you need help, and that’s where you guys or my books or whatever, our software can really rescue things.
Andrew Rafal: And the 8% increase each year up until age 70. People come in, and they just try to spreadsheet it out and they look at it as, okay, here’s my break-even point, but they’re not taking into account what we believe is so many factors, right? If they’re married or they’ve been divorced or ex-spousal, it’s how we’re protecting the surviving spouse, that’s a big piece because a lot of them don’t understand they’re going to get the higher of the two. But then also, right now, with the cost of living. and we haven’t seen this in many years, it’s been averaging sometimes zero, and now, we’re finally getting that increase, that 5.9. It doesn’t mean that they have more money in their pocket because of the cost of everything else, but it means they’re helping to keep up with that cost of living that is more expensive.
Larry Kotlikoff: Yes, even the risk of inflation we’ve been talking about, you want to have more and more of your resources in inflation-protected form. And that’s a very strong reason for being patient because as you’re patient, your benefits are going to be higher, and that means that a bigger share of your resources, your remaining lifetime resources will be inflation-protected. But let me just say one thing about kind of break-even in life expectancy, economics says, and we discuss this in Money Magic that we really have to plan for our maximum age of life. It may seem crazy, I should be planning to live to 100, that’s my maximum age of life, I suppose. Nobody in my family lived to 100.
Well, here’s a reason you have to plan to 100. It’s because you might live that long. And if you do live that long and you plan to die on time and your life expectancy, which is like 20 years before 100, or maybe 15 years, you’ll be living on cat food. So, what economics says is you have to plan to your maximum age of life, that’s your planning horizon. But since you know that you’re not likely to make it to 100, what you do is you arrange your spending so that your living standard gradually declines, maybe starting at age 80, maybe declines a half a percent a year. So, that’s how you arrange your finances, you spend more when you’re young and plan to spend less when you’re old, but not to have a plan that kind of ends when you’re supposed to die because you’re not going to die when you’re supposed to die. Nobody does. We either die too early or late.
My mom lived until 98. When she was 88, I told my brother and sister, “Mom’s 88, and we should buy her an annuity.” And at that point, you could buy an inflation-indexed annuity from the principal insurance company. And they said– my brother is a professor at Cornell. He won’t like me telling you this story. My sister ran some major corporations. She won’t like the story, but they’ll forgive me. So, I said to them, “Look, we have to buy her annuity.” They said, “You’re crazy. She’s 88. She’s not in great health. She’s only going to live for, at most, four years. That’s what the life expectancy tables say.” I say, “No, look, the problem is not if we spend this money and buy this annuity, we’re going to be protected if she lives to 100.” “That’s crazy. She’s not going to live that long.” “Well, how do we know?” “Well, the life expectancy.” “No, that’s just what happens on average. Our mom could live…” It turns out she lived until 98. It turned out that I insisted we buy the annuity, we bought the annuity. It was very important in protecting us because we were paying to support her in an assisted living facility and with aides, it was very expensive. So, if either of them gets too uppity, I just refer back to that.
Andrew Rafal: It’s good to use over the holidays. In that case, you looked at risk management and you offloaded the potential risk onto somebody else, and it could have…
Larry Kotlikoff: Yeah. If we look at life expectancy, we’re acting as if we got like a thousand lives to die. So, an insurance company can look at the average, can look at where people, let’s say, my age will die on average, but I’m only going to die once, and it could well be at 100. So, I’ve got to look at the downside. Just like when I buy a car insurance, I got to look at the catastrophic risks. On average, I’m not going to total my car. So, if we just looked at the averages, the average outcome, nobody would ever buy any insurance, whatsoever, because insurance comes with a load, there’s like transactions costs.
So, if we’re just thinking about break-even, nobody would buy health insurance, homeowner’s insurance, car insurance, life insurance, nothing. So, in the area of longevity, somehow, a lot of people think that we can play the odds, whereas in all the other contexts, everybody understands we can’t play the odds, so you cannot play the odds with longevity risk. Longevity risk is probably the biggest risk we face in old age.
Andrew Rafal: What are your thoughts on them? We talk about delay in Social and a lot of individuals with defined contribution plans, IRAs, 401(k)’s, they built up and accumulated a lot of assets, a lot of it pretaxed that will be then taxed later on when they start withdrawing from it. And I know every situation’s different, but are you a believer in having somebody look at drawing down certain assets in their retirement years before they start collecting Social?
Larry Kotlikoff: Yeah, I mean, let’s say, you retire at 62, should you take your Social Security money first? Or should you take your money out of your IRA? The answer is take the money out of the IRA because on a risk-adjusted basis, you get a fantastic return from Social Security, and it allows you a negative return these days on the IRA. Now, somebody will say, “Well, gee, I don’t want to take my money out of the IRA. The stock market’s been doing great guns.” Yeah, but the stock market historically, has huge volatility, so there’s nothing that guarantees. It is a random walk. There’s nothing that guarantees it’s going to do well in the future.
So, on a risk-adjusted basis, once you adjust for risk, the yield right now on the stock market is negative. That’s what inflation-indexed bonds are yielding right now, that’s the risk adjustment. You compare the average return on stocks with the return on inflation-indexed bonds, they’re called TIPS, Treasury Inflation-Protected Securities. They’re yielding today about negative 35 basis points. Right now, you could go to the Treasury, Google it, and you’ll see the real return is negative. But the return on Social Security is huge, and it’s also inflation-protected. So, yeah, you obviously want to time things for taxes too. You want to think about Roth conversions and you have to worry about your cash flow. You need enough money to sustain your living standard.
If you were to just wait until 72 to take your retirement account money and wait until 70 and you’re 62 and you don’t have a lot of assets and maybe you’re kind of house poor, you’re in a house with a lot of expenses, you’re going to be short on cash, right? You could be pretty rich, but also, you kind of have a huge amount of 401(k) money or IRA money and you’re saying I’m not going to be able to get to it. So, your tendency is to say, “Oh, I’m going to make a killing on the stock market because I’ve done well in the past, and therefore, I should take my Social Security right away.” And that’s a big mistake because you would give up a huge amount of Social Security benefits, lifetime benefits, and then the stock market crash tomorrow. And there’s no guarantee it’s going to come back up.
Andrew Rafal: Double whammy. And we’ve been in a lot of conversations and strategies on Roth conversions over these last few years. I know your software that you’ve spent a lifetime of building really helps the individual or planner look at the potential benefit of the Roth conversion. We look at it as, yes, it’s short-term pain, having to pay some taxes now. But what’s the long-term benefit? So, I know Roth conversions aren’t for everybody, but would you recommend that to look at it, at least, and to weigh it out and try to make for each individual case, look at it and say, what’s it going to help you with over the long haul?
Larry Kotlikoff: So, clearly, people could run our software and find out things precisely, but in this book Money Magic, what I did is try to think about different cases so that people who don’t want to run software could have an idea about how to think about it. So, one of the things I did in running cases on the program that I could talk about in the book was to look at somebody who’s on a low tax bracket, maybe they’re 64, they’re retired, low tax bracket, and they’ve got some traditional IRA money, and they want to do the conversion.
And what I noticed was that if they were taking Social Security early, that in many cases during the Roth conversion was a bad idea. Even though it looked like they were on a low tax bracket, when they took the money out, when they did the conversion, it pushed their modified adjusted gross income up by enough to initiate taxation of their Social Security benefits. So, their true marginal tax bracket was much higher. It wasn’t like, what’s the tax on the next dollar? It was like, what’s the tax on withdrawing $20,000 or $50,000 this year? Now, all of a sudden, I’m paying taxes on my Social Security benefits, where I was not otherwise doing that.
And furthermore, a year later, when I’m starting to take Medicare, now, I’m going to have to pay a higher premium on Part B because of this ERMA provision. So, these are the things I warn people about in the book that, okay, if you’re not taking Social Security, if you’re on a low tax bracket, if you don’t withdraw too much so that you would get pushed into a very high tax bracket, yeah, the Roth can make you some money. I show examples where it can make tens of thousands of dollars. But there are other cases where you can lose your money, even though it looks like it will make you money. So, this is like another financial shocker that you could be a low tax bracket and relative to where you’re going to be in the future and do a Roth conversion and end up actually losing from it.
Andrew Rafal: Most people don’t understand how the taxation of Social Security works with the formula, although it hasn’t been in what inflation hedge. So, it’s really low numbers there, but that’s something that really, software can help them see that. And you hit it right on the head on that where it could be an additional, in a sense, 10% tax that they weren’t counting on. Plus, the surcharges if they wait until 72, yeah, they’re not going to have any, but then they look and say their RMD, required minimum distribution, plus other income that they have is going to push them over that threshold. So, they’re going to have Medicare or ERMA surcharges for the rest of their lives.
And that’s, in a sense, a penalty. It’s a tax that they’re not taking it into an account. So, many fashions, it’s spreading out that Roth conversion and doing it in a manner where, from our side, it’s not like $300,000 in two years. It’s what if we did $50,000 a year over the course of five years, especially with the standard deduction doubled right now? So, it all comes down to software, though, we can’t explain that to somebody visually. They visually have to see it, and that’s where the software with a good planner can help at least make not always 100% right decision, but at least help you make the decision that probability-wise, is going to put you in the best shape that you can be in.
Larry Kotlikoff: Yeah, it is complicated. So, I just tried it in the book since not everybody likes to run a software, explain enough cases to give people a feeling for what is best for my circumstance. But you’re absolutely right, financial planning is more complicated than getting to the moon. And in our software, the actual code that we have uses the same kind of technology that they use to guide a spaceship to the moon because it’s something called dynamic programming. So, we actually have rocket science to do personal financial planning under the hood of our software. That’s what’s required because there are so many factors involved here. You said ERMA, Social Security, federal taxes, state taxes. The first 42 states with taxes and another nine without including the District of Columbia, all the provisions are different. So, it’s not child’s play.
Andrew Rafal: Your software, is it built because I use it on an advisor side, but if I’m an individual that doesn’t have a financial planner, I’m a do-it-yourselfer, is it something that I’d be able to step in and work without the help of somebody who’s an expert or “expert”?
Larry Kotlikoff: Yeah, so MaxiFi.com, our base plan program is $119. There’s a premium version where you can look at your investment risks to your living standards, and it’s all based on the economics approach to financial planning. So, it’s very different from conventional financial planning based on lifetime budgeting, trying to smooth your living standard, trying to raise it safely with these different– figuring out, is this going to save me taxes or raise my taxes? Is this going to raise my lifetime benefits? Can I downsize my home and dramatically raise my living standard there? Can I interrupt my equity? There are a zillion different things you can play with and different profiles and have fun.
But again, if you’re not into running software, it is very easy, and then we do sell it to lots and lots of individuals, thousands, but we have hundreds of millions of people in our country. So, we haven’t been selling it to hundreds of millions of people. Otherwise, I would be on the yacht talking to you. So, that’s where the book comes in, Money Magic, where I would say 85% of what the software is going to deliver to you, you can figure out from the book.
Andrew Rafal: Awesome.
Larry Kotlikoff: You can make a lot of calculations just with arithmetic in space because the real return is close to zero. So, you can assume basically, a zero-rate return and a safe return and make calculations just with elementary school arithmetic, adding, subtracting, division, multiplication.
Andrew Rafal: So, I could go on another two hours with you at least, but I know our listeners may have some other things to do until our next episode. But we’ve gone through a lot, economically where we are, some of it quite depressing, but no, and we have to stay optimistic that we’re going to hopefully come through and changes will be made and then sharing some tips and strategies of what people should be looking at, but then mistakes people are making, obviously, breaking this down inside your book will help people gauge out a little bit of what we just touched on the tip of the iceberg here. But before we end today, as we end 2021 into 2020, do you have any final thoughts or advice for the listeners before we end this year?
Larry Kotlikoff: Stay safe. Get vaccinated, get a booster, get three boosters, if you can. I mean, really, we’ve got too many people dying from this disease, too many people not trusting in science. We have to protect ourselves. We have to protect our kids and our relatives. We really have to get vaccinated. Nobody would say, “I don’t want to get a polio vaccine,” if we had polio raging in the country. And thank God, we have great scientists and we’ve developed the vaccines we’ve got and we’ll probably have to have more boosters given the variants. So, that’s my biggest concern, really, not with people’s finances, but with their lives and their health. And so, I want to push people in this last moment, to get vaccinated.
Andrew Rafal: We appreciate that. And the time that you’ve spent with us today and the listeners, this is wonderful, wonderful information. And again, it’s something that it is complex, you can either do it yourself or make sure that utilizing the resources, like your contributions. What I love are your weekly and monthly Ask Larry, and just going down that rabbit hole of all the different questions that people– a lot of it pertaining to Social Security, which is great stuff, listeners out there that you’ve been putting out there for years and years and years. So, we appreciate in our industry you doing what you’re doing, and it’s helping people make better sound decisions. And that’s the key. There’s just so much misinformation out there. So, we appreciate what you’re doing there.
And as we end, we’ll hope the Fed does everything they can to put us on a better track. We’ve talked about some of that earlier. And listeners, let’s just stay optimistic that we’re going to come through this and we’re all going to be able to live the standard of life that no matter if we live to 70 or 100 or 110, that we’re going to be in good shape.
So, Larry, thank you for all you do, all the show notes and a way to have access to the book when it comes out in January will be available in the show notes. And thanks again. We’ll look forward to talking to you potentially in the next few years. Happy planning, everybody. We’ll be back next month with a brand-new episode of Your Wealth & Beyond. Happy planning. Bye-bye.