Copyright 2013 John T. Reed
This an idea I just got today. Often when that happens, I overlook something. Please help me identify what I overlooked if anything.
Annuitants hurt the worst
The people who were hurt worst in past hyperinflations around the world were annuitants. In today’s America, annuitants would be anyone who now receives, or is due to receive in the future, monthly payments of social security or a pension. Lottery winnings, structured settlements, and other monthly payments over an extended period are not annuities per se, but almost.
Hyperinflation destroys the dollar
The problem with annuities in the U.S. is they are U.S. dollar-denominated. That means, if and when the USD hyperinflates, the annuity payments will soon have zero purchasing power. For example, I get $2,468 a month social security. Today, I got gasoline for $3.96 per gallon. That means that social security payment would enable me to buy $2,468 ÷ $3.96 = 623 gallons of gas.
The checks will keep coming during hyperinflation—for a while—but it may only buy, say, 10 gallons of gas at some point—when it won’t even buy what $1 buys today, the U.S. government will stop bothering to deposit them into my account and yours.
Can sometimes take a lump sum instead
With structured settlements and lotteries, you can generally choose to take a lump sum instead of monthly payments. DO IT if you have that choice. Atually, you have to look at the numbers. If the discount rate is too high, you’d be better off with the monthly payments. But generally, you can get a lump sum big enough that taking it is the smart play.
Can’t sell social security
But what about annuities and pensions. Generally you can neither sell them nor get a lump sum to cancel them.
You might make an inquiry to your pension payer if you get a private pension. Maybe they would rather pay you a decent lump sum to cancel the annuity. But I do not think either social security or government pensions will agree to switch to paying you one up-front lump sum. And those who can agree, like lotteries and private pension plans, may not agree to give you a big enough lump sum.
How can you manage the risk of hyperinflation to your annuity or pension?
What to do to manage the risk of hyperinflation wiping out the value of your social security or pension annuity?
How about a sort of reverse defeasance?
Hey, I am a nationally known real estate investment expert. In my travels in that field, I came across and wrote about defeasance of commercial mortgages. Defeasance is explained in my book How to Structure your Mortgage. It’s rather clever. Here’s a real rough description of it.
Commercial mortgage defeasance
You have a low-interest-rate mortgage on a property. You want to refinance. The existing lender says, “Great! We want to get that low-interest-rate mortgage paid off so we can relend the money at a better rate.”
But you don't want to pay it off—because of the low interest rate. You want to put a new first mortgage on the property. The new lender will only do that if the existing lender agrees to subordinate to the new mortgage. “No way!” says the existing lender as you would expect.
Defeasance lets you keep the existing mortgage and get the new one. The new one will be a second, which the new lender will absolutely not tolerate, until you explain this to them.
“I will go out now and buy enough U.S. government bonds to generate the income to make all the payments on the existing mortgage until it is paid off. Your loan will technically be a second mortgage, but because the first mortgage will be totally covered by the U.S. government bonds I buy and give to you, you have no risk as a result of being a second. So for all practical purposes, you will have a first.”
The trick is when you buy the new bonds, you will not have to buy as many of them (dollar amount) as the loan balance. Because the old mortgage has a low interest rate, and the bonds you buy will have a higher rate (normally), they can generate enough interest and principal to cover all the payments on the existing first even though the purchase price you pay for the new bonds will be less than the balance of the existing mortgage. You get to pocket the difference. That’s why you do the defeasance instead of pay off the old loan. This can also work if someone slaps a lien on your property but does not diligently seek to have the sheriff execute it.
Back to the annuities. Social security, for example, says I will get $2,468, adjusted annually according to the increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), until I die. One formula I saw in the Internet that used my health habits and such said my projected date of death is when I am 89—23 years from now.
So the question is, what is $2,468, adjusted annually for that CPI for the next 23 years (or maybe longer or shorter) the equivalent of in terms of a lump sum? It is a simple calculation albeit one that takes a financial calculator. There is one at http://www.free-online-calculator-use.com/present-value-annuity-calculator.html.
It says my $2,468 social security, paid monthly for 23 years is worth a lump sum of $467,414.88 if you use a 3.5% discount rate. I picked that rate because it is a current mortgage rate.
So how can I get that $467,000 or thereabouts—I won’t quibble over tens of thousands—in the form of a lump in return for my $2,468 social security? By law, I cannot sell it. But how about this?
Direct deposit and direct debit
I have the social security guys direct deposit the check into account A. I also get a 23-year mortgage loan on a property I own in the amount of $467,000 fixed at 3.5%. The monthly payment will be, not coincidentally, $2,468.
I put the loan proceeds into hard assets, like the property in question or selected foreign currency. That gets rid of the risk of the annuity becoming worthless due to USD hyperinflation.
Can you make mortgage payments with a worthless social security payment? Sure. The mortgage payment, remember, will also be fixed at $2,468, and therefore equally worthless because of the same hyperinflation. I direct the mortgage lender to automatically take the mortgage payment out of the same account A.
Insurance, taxes, maintenance
What about insurance on the property, property taxes, and maintenance?
Well, if it were raw land, you would get rid of the insurance and maintenance. Hard to get a mortgage on raw land though.
If it were a building, you would have to find the money to pay the insurance. If it were a rental property, the rent would pay it or much of it. And remember you still own the property and any equity in it. Even if it did not go up in value one penny, the 23 years of $2,468 monthly payments would pay off the loan and it would be free-and-clear at the end of the mortgage and you or your heirs would own it.
That’s better than you or your heirs owning nothing but the right to receive worthless hyperinflated deposits from the Social Security Administration monthly for 23 years. Remember the basic strategy for managing the risk of USD hyperinflation is to convert USD-denominated assets into hard assets or selected forex. In this case, we have done just that. You have transferred the risk of $2,468 USD becoming a worthless amount to the mortgage lender.
Risk of premature death?
What about the possibility of my dying before the actuarial tables say I will? In that case, the monthly social security deposits will stop, but the need to make the monthly mortgage payments will not. That’s an easy risk to manage. Just get mortgage life insurance. That shifts the risk of my dying prematurely to the insurance company. If I died prematurely, the mortgage life policy would pay the mortgage off probably by simply making the remaining payments as agreed.
What about the risk of my being Methuselah? That’s the U.S. taxpayer’s worry, not mine. If I outlive the mortgage, and the $2,468 direct deposits adjusted for those annual CPI calculations payments still have any purchasing power, I will get them and enjoy spending them—probably on a “value meal” at McDonalds.
Pledge security other than real estate?
Could you do something else with the lump sum other than buy real estate? Yeah, but you gotta qualify for the loan.
If you buy stocks with it, you can pledge them for security on the loan. I doubt you will get $467,000 in that arrangement, but you will get something. With each passing month, as the loan is paid down, you could take possession of that amount of stock.
That is a margin loan. If the stock went up in value, the percentage you would have to pledge would go down and you could take even more out. On the other hand, if the stock went down in value, you would get a margin call requiring you to put up even more stock or cash. How would you manage that risk? Well, this is getting complicated, but you could hedge that risk by shorting the same stock or index that you pledged as security. That way, the profit you made on the short would offset the amount you lost on the stock pledged as security.
If your situation permits, you could use a H.E.C.M. loan. There is a whole chapter on that in the second edition of my book How to Protect Your Life Savings from Hyperinflation & Depression. In the first edition, that chapter was about college savings funds. The H.E.C.M. is crudely called an FHA reverse mortgage. Actors Henry Winkler and Fred Thompson are doing ads on TV for the companies that make those loans. Basically, if you fit, they give you a lump sum. The mortgage has no payments. So you would get to live in the house AND get to keep the $2,468 monthly social security payments. The interest simply accrues until you die or move out of the house for more than a year. At that time, the loan and accrued interest must be paid off. If the house is not worth enough, that’s the lender’s tough luck. It is a non-recourse mortgage.
If the house is then worth more than the principal and interest owed, you (if you moved out rather than died) or your heirs get the equity. Fantastic good deal. Heads you win and tails the FHA loses.
Convert annuities into lump sums through debt
The basic big picture idea here is for you to convert your social security and other pensions that cannot be sold or assigned into lump sums by borrowing. The fact that you are due the social security and pensions will help you qualify for the loans. Then you invest the loan proceeds into hard assets or well-selected foreign currencies. Mine are in AUD, CAD, NZD, and CHF.
If you follow this advice, and we get hyperinflation, your older friends and relatives will be alternately crying the blues and screaming in outrage at how they worked their whole life and now…yadda yadda. You, however, will be just watching your worthless pension checks flow into an account to pay your equally worthless loan payments of equal amount while you simultaneously enjoy the benefits of having invested the lump sum loan proceeds into hard assets or stable forex (foreign exchange or currencies).
Alternatively, if you reject the advice I am giving you here today—maybe because it made your eyes glaze over—you will, at the time of the hyperinflation—be hit by a bolt of realization that on 5/10/13, that Reed guy had explained to you how to avoid this financial catastrophe, but you didn’t want to strain your brain to look into it. That would make you just like Austrian Anna Eisenmenger who rejected her banker’s advice to buy foreign currency at the beginning of the hyperinflation there. Why did she do that? Her “explanation” was, “Oh, I don’t know anything about those financial things.”
Within months of her ignoring her bankers advice to get her money out of Austrian Krone and into Swiss francs, Dutch guilders, or U.S. dollars, she lost 3/4 of her net worth to the Austrian hyperinflation. So I guess Anna, who did not want to bother her pretty little head about “financial things,” learned rather quickly that her attitude was unacceptably suicidal in a world where hyperinflation is a possibility.
So you can learn that like Anna—the hard way—or you can learn it the much easier way by going back up to the top of this article and reading it again to force yourself to understand it, then look into doing it.
Those hurt most during hyperinflation are annuitants and pensioners. If you are one, I just gave you a rough way to convert your future annuity payments into a lump sum of money now that you can put into hard assets like real estate or commodities or food or well-selected foreign currencies or into quasi-hard assets like stocks which at least have a chance to survive hyperinflation. USD pensions have no chance to survive it.
Foreign currency annuities
What about trading your USD annuity for one in AUD, CAD, NZD, or CHF—or better yet, all of the above? That would be a neater solution and would work assuming those currencies do not hyperinflate as much, or more than, the USD. And a private pension payer might agree readily. What do they care as long as there is no cost to them to do it, or if you agree to pay the cost?
A number of my West Point classmates and other former military people are in the habit of reading my web articles. They often get social security, a military pension, and maybe double-dip or triple-dip, post-army, civilian government job pensions.
That’s a profoundly scary reliance on annuities, guys. There will probably be some magazine article during the hyperinflation about which category of Americans were its dumbest victims. I nominate the triple dippers for that title. It is hard to imagine a worse career and personal financial course—heading into probable hyperinflation—than relying on annuities and pensions.
Unless they read this article and take appropriate action before it happens.