It has been interesting following the various offerings on this blog having to do with economics, physical possession of precious metals (PMs), IRAs, and such. I believe I have some things to add to the conversation that I have not seen mentioned before and that may be of interest to “preppers”.
By way of introduction I consider myself a “survivalist.” I have a degree in Business Economics from a major university. Furthermore, I have been working in the world of banking/finance for the past 30 years. What I am about to offer does not constitute investment or tax advice, rather it’s my view of things from my little corner of the world. I have nothing to sell and no affilition with anyone who does. We may disagree on some terminology or exact numbers, so it is my hope that we can focus on the big picture and what it paints rather than disputed minutia.
How is the economy really doing?
The debt this country now carries, as well as the debt of most civilized countries of the world, not to mention the unfunded liabilities cannot be repaid, ever! Since the near collapse of 2007-2008, the stock market has been fueled (pumped up) by the flow of printed money (Quantitative Easing 1, 2, 3, and 4; operation twist; bail outs; et cetera) rather than by corporate earnings. The money isn’t really even printed any more; it’s electronic.
Allow me to explain how Quantitative Easing (QE) works. We have recently been functioning with both QE 3 and QE 4 running simultaneously to the tune of $85 billion per month. The “tapering” down that has recently occurred represents $10 billion per month. So, between the two we are now at $75 billion per month. The mechanics of that are this: Every month the U.S. Treasury (UST) electronically creates (out of thin air) $85 billion (or $75 billion at the moment) U.S. dollars. They wire this amount to a private entity, known as the Federal Reserve (Fed). The Federal Reserve then uses part of that money to buy U.S. treasuries (back from the U.S. Treasury) and part goes to large banks to buy troubled mortgage-backed securities from them. The Federal Reserve then owns those investments. When the banks “sell” their assets to the Federal Reserve, they take billions of dollars a month in cash that they are supposed to be lending out to stimulate the economy, yet large amounts end up going to buy stocks. Those “inflows” are why the stock market went up for several years in a row.
If you didn’t follow that explanation, let me make it simpler. The U.S. Treasury uses computers to digitally create “money,” then wires it to the Federal Reserve, who uses that “money” to buy bonds that the UST is selling. Thereby, the UST gets the “money” back for “selling” the bonds all to keep the government afloat. If you or I did that, we would be put in jail in short order and rightly so.
Now let’s look at the cumulative effect of this. Let’s set aside all the bailouts– Fannie, Freddie, AIG, GM, and so on. Let’s set aside QE 1, QE 2, operation twist, and so on. We also will set aside the debt going into 2007. Aside from all the previously mentioned financial manipulations and indebtedness, QE 3 has been running for 15 months and QE 4 for 12 month. So, that is approximately $1.170 Trillion dollars “printed” to prop up our government in just the last 15 months! Wait, there is more (and you thought there was a “recovery”).
Where did that $1.170 trillion dollars go? It is part of the investment portfolio of bonds and mortgages that the Fed owns, right? The Fed receives interest and principal payments for maturities of those bonds every month (just as you would if you owned them). How much is that? I don’t know for sure, but the Fed just recently announced that their total portfolio is about $4 trillion. While we don’t know what their average yield is, what percentage of the portfolio is “nonperforming”? My guess is that their entire portfolio brings in about $60 BILLION in income and maturities PER MONTH! (I believe that estimate to be on the low side.)
What does the Fed do with that money? They buy more U.S. Treasuries. Let’s add that to the mix $60B + $85B = $145B. Right! It is taking $145 BILLION DOLLARS PER MONTH to keep the wheels on. That is approximately (just shy of) $2 TRILLION DOLLARS that has been “printed” in the last 15 months, just to prop up our government. This, of course, is in addition to tax receipts and bond sales to entities other than the Fed.
Why are some people “defunding” retirement accounts?
For one reason the “math” above scares the dickens out of them.
I believe that with the flip of a switch, the government could “nationalize” all IRA’s, 401k’s, 403b’s, and so on. Possibly, you’re the optimist of the family, and you don’t think the government is going to steal your retirement funds. You think “they” are going to turn this ship around without an economic collapse. With that outlook, why then have money in an IRA account? The answer is “deferral,” meaning you are deferring the payment of taxes due on those assets to a later date. So, by not paying the taxes now, you have more money in the account and invested.
When talking about traditional IRA’s, what I tell people (no matter what their age) is not to think it’s all yours; it’s not. You have a partner in that account by the name of Uncle Sam. Part of the assets belong to you and part belong to Uncle Sam. Your job is to figure out how to buy out your “partner” as cheaply as possible.
In accounting language, we “recognize” there is a tax liability associated with the money in our IRA, but we choose to not “realize” it until a later date. Again, why? Well historically, the assumptions to that decision are 1) that when we retire (stop drawing a paycheck) and start taking income from the IRA, our marginal tax rate will be lower than it was when we were working, so we will get by with paying less tax on the distributions, and 2) that inflation will stay more or less the same. The “economic real rate of return” is your gains on investment minus taxes and inflation. So, say your IRA gains 8% in a year. It’s growing tax deferred (no taxes now) and inflation is 3%. Your economic real rate of return is 5% (8% minus 3%). Make sense?
How does this “blow up”?
- If things keep humming along and TPTB can keep things cobbled together, the only option to pay debt is to raise taxes. We are not going to “grow” our way out of this. My friend, who emigrated from Finland, told me that when he left he was paying taxes at the 85% marginal bracket. Here in the U.S., if you take an IRA withdrawal now and pay 30% in taxes, you obviously keep 70%. However, if in ten years you would pay 60% in taxes, then by taking your money out now and buying out “your partner” now, you would be WAY ahead. If things stay together, tax rates will go up. Conventional wisdom is to plan that, at worst, when you retire your withdrawals will be taxed at the same rate as when you were working. Nobody wants to get their head around the possibility of tax rates being double (or more) in ten or fifteen years.
- Inflation. Let’s say that the money supply is five trillion U.S. dollars. Then, five trillion more dollars are printed. Since dollars are only backed by “the full faith and credit of the U.S. government” rather than gold, the value of the existing dollars in circulation is cut in half. That leads to inflation. To say it another way, “the time value of money” means dollars today are worth more than dollars will be tomorrow, even in normal inflation. However, with inflation of 25% per year, a candy bar costing a buck at the beginning of the year can be purchased in a quantity of 100 with $100. At the end of the year that same $100 will buy only 75 candy bars. The dollars at the beginning of the year were more valuable than the ones at the end of the year. Dollars that you withdraw from an IRA today will have more purchasing power than dollars you withdraw later. You might reply that that is okay because the money in your IRA is invested and growing. That’s fine, but they could be invested and growing outside an IRA account also, with no partner to take a portion of all of your gains.
When you take the pieces of paper known as dollars and convert them to hard assets that store value (not to mention that can go up or cost more later), it can be a good investment. I did this with dog food. We purchased a year’s worth of dog food at first and tracked it. The inflation of dog food that year ran 16%. So by purchasing it in advance, our “internal rate of return” was 16%, with the only risk being if it got infested or for some reason couldn’t be used. That’s a pretty low risk proposition for that rate of return.
Roth IRA Conversion
Some people with traditional IRA’s are eligible to convert them to Roth IRA’s. You pay taxes when you convert, so you succeed at buying out your partner, but typically they are not suited to physical possession.
10% Penalty for Early Withdrawal
In my mind that penalty is simply the cost of playing the game. If the asset is only “recognized,” then it is merely on paper. You have to “realize” it in order to take possession (save the IRA LLC referenced below). The taxes (as above) were not created by taking a distribution; they have always been there. You just decided to buy out your partner now. Alternatively, you can look at the 10% penalty as insurance that you will always have control of those assets.
What about the IRA LLC vehicle that was mentioned in Will Lehr’s recent blog article, I will admit to only knowing as much about the subject as he and his web site provides. It’s an interesting concept and would seem to be most beneficial to investors with large IRA balances. That way you could justify the upfront legal fees. I agree that if you start defunding an IRA with multiple six figure balances, you are going to experience tax bracket “creep” and get hit awfully hard with taxes. My philosophy on that is that if you are not paying taxes or are in the 15% marginal tax bracket and you have an IRA, you should absolutely be taking distributions to fill up the 15% “bucket,” at a minimum. Don’t ever expect to get off paying taxes at a rate of less than 15%.
What I like about the IRA LLC vehicle is that it is:
- Invested in Precious Metals, and
- Allows for physical possession without taxation. Remember if you can’t touch it, stack it, and count it, then you don’t own it.
My concerns would be:
- That is a pretty rare and sophisticated way to manage IRA assets, and this creates some questions that I don’t have answers for. Would the IRS view that as “hiding” or attempting to “hide” assets? Wouldn’t the IRS then know that you have PM’s in your possession?
- In the IRA LLC, you have not “bought out” your partner Uncle Sam. If you do very well and double your money, you have just doubled “Uncle Sam’s” take also. If tax rates go up in the future, you take the hit for that.
After a review of their web site, here are my thoughts, considerations, and unanswered questions regarding the IRA LLC:
- Are you required to purchase your PM’s from Perpetual Assets? I would guess, yes.
- I noted that as of this writing, their commission charges for a one ounce Gold Eagle is 5.2%. I personally don’t think that is out of line, but it is a factor to consider. If you have to purchase your PM’s from them, then the fees/costs were not fully disclosed.
- Do you have to sell to them?
- Is there also a charge to sell?
- Are there charges, other than shipping, for taking physical possession?
In fairness Mr. Lehr said up front, “This platform has its pros and cons”.
I hope my thoughts and observations will be helpful. I recognize they are certainly a departure from what the main stream financial media is spoon feeding the sheeple.
Good luck and God bless.