Friday, April 7, 2017

Overpaying PBGC Premiums -- Money You'll Never See Again

Earlier this week, October Three released what may have been the most comprehensive study ever on payment of PBGC premiums. The study analyzed premium payments of nearly every mid-sized or large defined benefit plan in the country over the period from plan years 2010 through 2015 (leaving out plans with fewer than 250 participants).

The key results were shocking:

  • During that six-year period, companies overpaid variable rate premiums by more than $700 million in the aggregate. That is, using techniques designed to lessen variable rate premiums, they could have paid $700 million less.
  • For the 2015 plan year, more than 65% of plans that paid variable rate premiums, and did not have their premiums limited by the so-called per participant cap, paid more than they needed to.
If we think about this particular pension expenditure, one could consider it among the worst of all sins. For example, if you contributed more than you needed to in 2015, then your future required contributions will be lower, your PBGC premiums may have been lower and your pension expense will have been lower. So, while you may have had other uses for the money, at least you got some benefit from those contributions.

On the other hand, suppose you paid a larger variable rate premium than you needed to. What benefit have you gotten or will you have gotten from that overpayment? Zero. Zilch. Nada. Nihil. Niets. Niente. Rien. They're all the same. You will have received absolutely no benefit from your overpayment and neither will your employees. In fact, the only beneficiary of your overpayment will have been the PBGC.

Don't get me wrong. There are some good people, some nice people at the PBGC. I have friends at the PBGC. But, that said, there is no reason to give them more money than you need to under the law.

If you've made it this far, I'm going to leave you with an analogy. PBGC premiums are a lot like taxes. You pay money to a quasi-governmental corporation (PBGC) as a condition of sponsoring a defined benefit plan. Similarly, you pay taxes to the federal government when your company turns a profit.

Here is where they diverge. Your company probably has a Tax Department. If it does, its primary function is to ensure that your company properly pays its taxes, but in as small amount as legally allowable. That is, their job is to reduce your tax burden.

Your Tax Department may be pretty big. How big is your PBGC Premium Department? Oh, you don't have a PBGC Premium Department? You know you could.

Tuesday, April 4, 2017

409A and the Reverse Haircut

No, you didn't read the title incorrectly. I used the term "reverse haircut." Don't go scouring google for it, though. I made it up, or at least I think I did.

What happened is that I was catching up on reading and in going through documents that I had received from a number of sources, my eyes fell on Chief Counsel Advice 201645012. I know -- it's not one of the biggies that caught your eyes. So, that's why I'm reporting it here.

Here are the salient facts from the Memorandum:

  • On November 1, 2014, an employee entered into an agreement to defer $15,000 of the employee’s salary that would otherwise have been paid during 2015, with payment of the deferred amount to be made as a lump-sum payment on January 1, 2018, but only if the employee continues to provide substantial future services until December 31, 2017.
  • Under the agreement the employee’s salary is reduced by $600 each biweekly pay period (so 26 x $600 or $15,600) and the employer credits matching amounts to the employee’s deferred compensation account of 25% of each salary reduction (so 26 x ($600 / 4) or $3,900) for a total amount deferred of $19,500.
  • The matching amounts are credited each time a salary reduction amount is credited, which is the time the salary reduction amount would otherwise be paid as salary.
The issue here is whether the potential loss of the 25% matching contributions represented a substantial risk of forfeiture as compared to a risk of forfeiture. And, that is the reverse haircut approach. That is, the employee will receive those matching contributions only by providing future services.

People used to the qualified plan world may be a bit mind-boggled at this point. To them, this looks like a vesting condition, walks like a vesting condition, and quacks like a vesting condition, so it must be a vesting condition. And, the potential failure to vest must represent a substantial risk of forfeiture -- a term that doesn't exist in the qualified plan world.

Suppose, however, that the 25% was less, say 20%. Then what? Perhaps there would still be a substantial risk. Or, perhaps there would just be a risk. How about 15%? How about 10%? 

At what point would the potential diminution in compensation be so insufficient that its loss would not be material and therefore there would fail to exist a substantial risk of forfeiture? Or put differently, at what point would enough hair be returning to our hero's head that its loss would leave him wondering how he could go through the rest of his life so improperly coiffed?

What we know is that in this particular case, 25% was deemed by Treasury to be sufficient. In fact, the Chief Counsel Advice included the following language:
Yes, an amount that an employee could have elected to receive as salary may be treated as subject to a substantial risk of forfeiture under section 409A if the employer provides a matching contribution resulting in a 25% increase in the present value of the amount deferred.
How useful is that to you and me? Not very. CCA's cannot be relied upon for any precedential value. While Treasury is usually consistent in its administration of such issues, there exists no requirement that it be. We also don't know if, for example, 20% would have been sufficient. Or 15%. Or 10%. To any attorneys reading this, it must feel like a hypothetical in their law school contracts class.

We also don't know if the deferral period in question had anything to do with the decision of Chief Counsel.

What we do know is that roughly 6 months ago, based on all of the facts and circumstances of this particular situation, Chief Counsel deemed that the 25% reverse haircut was a material incentive and that such materiality did create a substantial risk of forfeiture.

Tuesday, March 21, 2017

Don't Make the Federal Government Your Company's Favorite Charity

You work at a decent sized company. That company has a Tax Department. The primary jobs of the Tax Department are to handle the company's taxes legally, and in doing so, to recommend and implement strategies that generally minimize those tax obligations.

Gee, everyone knows that, don't they?

Why do you want to minimize your tax obligations? Well, once you pay out money, you don't get it back. And, if for whatever reason, you happen to view the IRS as your favorite charity, you, the individual (or individual corporate) taxpayer don't get any more or better services for having given them extra money.

It doesn't work that way. In fact, the Internal Revenue Code is a ridiculously complex set of rules that, in total, generates revenue for the federal government. The federal government doesn't check to see who failed to take deductions that they could have and either call them out as being wonderful citizens or provide them with extra goods or services commensurate with the additional taxes that they paid. It doesn't work that way.

During the course of running a business, companies will find that they have large number of payments that they make to governmental or quasi-governmental agencies. For example, banks pay premiums to the Federal Deposit Insurance Corporation (FDIC). They do this so that their customers can feel secure in knowing that their deposits are backed by the United States government (to a point). Premium amounts differ by being in different risk categories. In other words, to some extent, a bank can control the amount of FDIC premiums that it pays.

Similarly, sponsors of defined benefit pension plans pay premiums to the Pension Benefit Guaranty Corporation (PBGC). Those premiums fall into two categories -- the fixed amount per person and the variable amount related to how well the plan is funded. Both of those amounts can be managed, and companies by and large either have been advised to or figured out on their own how to manage the fixed part. The variable rate premium is another story. While there has been a lot of press telling companies to borrow to fund their plans thereby reducing variable rate premiums, there are other techniques that exist.

It all comes down to paying the amount that the law requires you to or paying more. Paying more doesn't get you a trophy. Paying more doesn't get your employees trophies either -- not even participation trophies..

Suppose I told you that you had been overpaying your PBGC premiums by, let's call it, 15X per year. And, suppose I told you that by spending X one time, you could stop doing that. Would you do it?

Monday, March 6, 2017

What Does Your Plan Document Really Say?

What does your plan document really say?

That's right. You read my question correctly. You probably know the words that are there. And, you certainly know what they say. But, would everyone else agree with you? That may be the really key question.

Let's limit our discussion here to retirement plans, both qualified and non-qualified. Those are usually complex documents. They contain an awful lot of words that are intended to both inform the plan participants of their benefits and attendant rights and to tell the person or people administering the plan exactly how to do that. And, we all know that because the English language is so precise that no two people would ever disagree on the meanings of those words, would they? Of course, they would, and they often do.

Perhaps that's a key reason that there is so much litigation related to retirement plans. If a plan participant took his summary plan description (SPD) and calculated his own monthly benefit and determined that it was $2,000 and a few weeks later, he received a benefit determination that his monthly benefit would be $1,000, he's not going to be happy.

Perhaps his reading of the SPD was irrational. Perhaps the SPD specifically says everywhere that pensionable earnings shall be based on the participant's years with highest base pay and he read that to include bonuses and car allowances and equity grants as well.

On the other hand, perhaps his reading was different than yours, but rational. To quote Scooby Doo (I always wanted to quote Scooby Doo in a retirement benefits post), "Rut ro."

How do we avoid this problem?

There are presumably legal safeguards that are typically inserted into a plan document to get past this problem should it occur. Clearly, however, they don't always work. If they did, no plan sponsor would ever lose in litigation. We know that's not reality.

To help to ensure that you're not one of those litigation losers, wouldn't it make sense to have an independent review of those documents?

I'll leave it up to the attorneys to tell you how that should be structured. But, I am going to tell you that it's important to have attorneys and non-attorneys working together on this review.

Why? Attorneys certainly know how to read documents, especially the ones that they write. But, in practice, they won't be administering your plan. And, a person without legal training may read those legal words differently than an attorney will.

Additionally, since we are talking about retirement plans here, administration may include what I've heard a number of attorneys refer to as a dirty word -- math. While some are very good at it, I've heard many attorneys say that math was always their worst subject in school. They fought through it, but they never understood it.

And, sometimes, those plan documents serve to prove that. Suppose the attorney wrote the document to mean exactly what he thought it was supposed to. But, perhaps to a person with a little bit better understanding of the math involved, the calculation would work out differently. I'll say it again -- rut ro.

Use counsel as you should. Consider getting them to engage consultants on your behalf who can help them and you to understand when your plan may be interpreted differently than they had intended. By saving litigation costs down the road, it may be the cheapest money you've ever spent.

Monday, January 2, 2017

Thinking About the Year Ahead in Benefits and Compensation

I was talking to a member of the benefits press the other day and after the formal interview (for an article) was over, the reporter, looking for ideas for 2017 articles, asked for a favor. Paraphrasing, if I were running a Benefits or Compensation, or HR function at a good-sized company, what are some things that I would make sure that I did in 2017 including perhaps some things I had not done in the past?

I thought that was a pretty good topic. It's something I think about from time to time and frankly, I'm hoping that that reporter will think of me in the future when writing on some of those topics.

But, if you are reading this, you might be one of my faithful (or first-time) readers and you probably don't want to wait for those articles. So, I'll give you a little preview with a few of my thoughts.

Be a Better Partner

I know -- that sounds strange for Human Resources. People in HR virtually always think of themselves as good partners for the rest of their organization. But, perhaps surprisingly to our HR heroes, their colleagues might not agree.

To Finance, HR is a cost center. Face it, HR doesn't make money. HR doesn't have a product. HR doesn't sell goods and services. HR costs money. And, because of that, Finance may not think of HR as good partners. So, if you want to be better thought of by Finance, think in terms of dollars and cents. When you find a solution that saves money, make sure your Finance partners know about it and make sure you get some credit for it.

Somewhat similarly, Legal may think of you as a litigation risk. After all, there may be more laws on the books that deal with how an employer treats an employee than any other area. And to Legal, each one of those may represent a risk. Legal would like nothing better than to know that you have sound processes and procedures and probably more importantly that you are following them. It's amazing in reading through employment litigation how often a case falls apart for the employer because they had a set of procedures and they left a few steps out in, for example, terminating an employee.


Implementing Those Partnerships

It's great to think about those partnerships, but thinking about them isn't very useful if we don't do something with those thoughts. Let's consider Finance first.

Most every element of your department has a cost associated with it. For 2017, I'm sure you have budgets. But, how about years after 2017? That's a little bit tougher, isn't it? Some of your costs are controllable. You can manage your payroll by the general cost-of-living type increases that you provide. How about your pension commitments? That's a tough one, huh?

First off, your actuary should be on top of that. You should never be getting a pension surprise from year to year or even quarter to quarter. You're not one of those who is getting surprises, are you? If you are, you don't need to be.

I've spoken with benefits people in the past who tell me that's a nice goal, but we just don't have much budget, we really don't have time and we don't have the staff to work with you so that you can get us what might be useful to us.

Suppose I told you that you don't need much budget. This is a very inexpensive project. In fact it's so inexpensive that more often than not, we'll save you more than you spend.

Suppose I told you that we don't need much of your time. In fact, I'm going to round up and say I need 15 minutes of it, but in reality 2 or 3 minutes will probably suffice. Although, to be fair, when I do have results for you, you'll probably want to save an hour or more to go through what we've found for you. After all, what good would discovered savings do you if you didn't actually know how to get them.

And, then there's that staff that you don't have to get us information and answer our questions. Don't worry -- I said that I don't need more than a few minutes of your time. It turns out that I don't need your staff's time either. It's true. All of what I said is true.

Turning now to partnering with Legal, you don't want your department to be thought of as a litigation risk, do you? Well, with respect to each of your plans and programs, you probably have a whole bunch of processes and procedures?

  • Are they current? When was the last time they were updated? When was the last time anyone even looked at them?
  • Are you following them? Every one of them?
  • Do they still make sense? Would you make changes to them not because the law changed since that would necessitate changes, but because they're just not really appropriate in 2017?
I know, this all seems a bit pie in the sky. But, read through your favorite benefits digest tomorrow. There's probably something in there about litigation. What went wrong that caused a lawsuit to have a chance?
  • A committee did not use a well-reasoned process in selecting plan investments.
  • A committee actually had such a process, but didn't follow it.
  • A plan document was vague enough that two reasonable people might interpret it differently. Counsel is telling you that you will win because of this notion sometimes known as "Firestone deference" (essentially, the administrator of a plan should have broad latitude in its administration), but even if you win, litigation may be costly and eat up a lot of your resources.
  • You had a low performing individual in the company whose supervisor doesn't like documenting performance reviews, so when that individual was terminated, there was no written basis on which to do it.
I could go on, but you get the gist. But looking at all those things is tedious and you just don't have the staff to do it, but there is a solution.

Happy New Year. Have a great 2017.

Friday, December 2, 2016

Instead of Making Defined Contribution Look More Like Defined Benefit, ...

I don't think I've ever ended the title of a blog post with an ellipsis before. But, surely, there's a first time for everything.

Lately, the benefits press has written an awful lot about what must be the latest trend in employer-provided retirement benefits -- making the defined contribution (DC) plan look more like the defined benefit (DB) plan. Perhaps I am missing something, but it appears that this "major" initiative has two components to it (that's right, just two):

  • Communication of an estimate of the amount of annuity a participant's account balance can buy
  • The option to take a distribution from the plan as either a series of installments or as an annuity
Let's consider what's going on here.

Annuity Estimate

Yes, there is a huge push from the government and from some employers to communicate the annual benefit that can be "bought" with the participant's account balance. Most commonly, this is framed as a single life annuity beginning at age 65 using a dreamworld set of actuarial assumptions. For example, it might assume a discount rate in the range of 5 to 7 percent because that's the rate of return that the recordkeeper or other decision maker thinks or wants the participant to think the participant can get.

I have a challenge for those people. Go to the open annuity market. Find me some annuities from safe providers that have an underlying discount rate of 5 to 7 percent. You did say that you wanted a challenge, didn't you?

I'm taking a wild (perhaps not so wild) guess that in late 2016, you couldn't find those annuities. In fact, an insurer in business to make money (that is why they're in business, isn't it) would be crazy today to offer annuities with an implicit discount rate in that range.

But, annuity estimates often continue to use discount rates like that.

Distribution Options

Many DC plans offer distribution in a series of installments. Participants rarely take them, however, For most participants, the default behaviors are either 1) taking a lump sum distribution and rolling it over, or 2) taking a lump sum distribution and buying a proverbial (or not so proverbial) bass boat.

Why is this? I think it's a behavioral question. But, when retiring participants look at the amount that they can draw down from their account balances, it's just not as much as they had hoped. In fact, there is a tendency to suddenly wonder how they can possibly live on such a small amount. So, they might take a lump sum and spend it as needed and then hope something good will happen eventually.

Similarly, if they have the option of getting an annuity from the plan, they are typically amazed at how small that annuity payout is. And, even with the uptick in the number of DC plans offering annuity options, the take rate remains inconsequentially small.

A Better Way?

Isn't there a better way? 

Part of the switch from DB plans to DC plans was predicated on the concept of employees get it. They understand an account balance, but they can't get their arms around a deferred annuity. So, let's give them an account balance.

Part of the switch from DB to DC plans was to be able to capture the potential investment returns. Of course, with that upside potential comes downside risk. Let's give them most of that upside potential and let's take away the worst of that downside risk. That sounds great, doesn't it.

Once these participants got into their DC plans, they wanted investment options. I recall back in the late 80s and early 90s that a plan with as many as 8 investment options was viewed as having too many. Now, many plans have 25 or more such options. For what? The average participant isn't a knowledgeable investor. And, even the miraculous invention commonly known as robo-advice isn't going to make them one. Suppose we give them that upside potential with professionally managed assets that they don't have to choose.

Oh, that's available in many DC plans. They call them managed accounts. According to a Forbes article, management fees of 15 to 70 basis points on top of the fund fees are common. That can be a lot of expense. Suppose your account was part of a managed account with hundreds of millions or billions of dollars in it, therefore making it eligible for deeply discounted pricing.

There is a Better Way

You can give your participants all of this. It seems hard to believe, but it's been a little more than 10 years since Congress passed and President George W Bush signed the Pension Protection Act (PPA) of 2006. PPA was lauded for various changes made to 401(k) structures. These changes were going to make retirement plans great again. But, for most, they didn't.

Also buried in that bill was a not new, but previously legally uncertain concept now known as a market-return cash balance plan (MRCB). 

Remember all those concepts that I asked for in the last section, the MRCB has them all. Remember the annuity option that participants wanted, but didn't like because insurance company profits made the benefits too low. Well, the MRCB doesn't need to turn a profit. And, for the participants who prefer a lump sum, it would be an exceptionally rare (I am not aware of any) MRCB that doesn't have a lump sum option.

Plan Sponsor Financial Implications

Plan sponsors wanted out of the DB business largely because their costs were unpredictable. But, in an MRCB, properly designed, costs should be easy to budget for and within very tight margins. In fact, I might expect an MRCB to stay closer to budget than a 401(k) with a match (remember that the amount of the match is dependent upon participant behavior). And, in a DB world, if a company happens to be cash rich and in need of a tax deduction, there will almost always be the opportunity to advance fund, thereby accelerating those deductions.


It is a win-win. Why make your DC plan look like a DB when there is already a plan that gives you the best of both worlds.

Monday, November 28, 2016

Saving for Retirement in a President Trump World

I know this sounds like a politically charged topic, but it's not intended to be. I just want to pose the situation to let readers know a few things. While the Trump platform didn't particularly address retirement issues, how will retirement be affected?

In order to understand this, let's consider a few key non-retirement items that both the Republican-controlled Congress and President-Elect Trump have weighed in on to one extent or another:

  • Repeal of the Affordable Care Act (ACA)
  • Replace the ACA with a framework that is expected to feature competition across state lines, high-deductible health plans (HDHPs) with Health Savings Accounts (HSAs), and a la carte shopping for health plans (you insure what you want to insure to the extent that such coverage is available)
  • Simplified (somewhat) Tax Code with lower marginal tax rates for most taxpayers
  • Elimination of the Head of Household status for filing taxes
As I've remarked many times, our current retirement system for American workers is not what it was, for example, 30 years ago. It's no longer the norm to have the solid three-legged stool of
  • the defined benefit (DB) pension plan from the company you spent most of your career with
  • your personal savings in a high-return savings or money market account (you probably even had your choice of a free toaster or alarm clock when you opened the account)
  • Social Security
Recall that 401(k) plans were in their infancy and even employees who had them didn't tend to make heavy use of them. 

Under the new [proposed] regime, personal responsibility will be king. Out of your higher after-tax income (not significantly higher for most Americans unless the economy booms to where employers are inclined to offer higher compensation to their employees), you'll need to save for retirement and make HSA deductions to accumulate a rainy-day fund just in case you have a high-cost medical expense. Is that practical?

Under the ACA, $10,000 annual health care deductibles are not all that uncommon. So, you'll want to build up your HSA account to ensure that you're not bankrupted by a large medical expense or even by one that you choose to not purchase coverage for. Let's say you choose to defer the family limit for 2017 -- $6,750. Further, since you've been reading about it online, you need to defer, say, 10% of your family income of $75,000 per year (or $6,250 per month) (well above the national median of about $52,000) or $7,500 to your 401(k). Let's add to that your $2,000 per month house payments (including escrow) and your $750 per month car payments (including insurance) and see where you are before basics like utilities, food, and clothing.

We start with $75,000 and let's pull out 22% of that for federal, state, and FICA taxes bringing you down to $58,500. Let's take out another $4,000 per year for health care through your employer (we'll assume they are subsidizing it) and you're down to $54,500. Now subtract your HSA, 401(k), house payments, and car payments and you're down to $7,750. That's $650 per month to pay for food, clothing, gasoline, and to build up a rainy day account, and you haven't even had a chance to buy anything because you just wanted it.

As they said in the movie, something's gotta give. What's it going to be? My guess is that the first thing you cut back on is your retirement savings. You'll worry about that in some future year. Or, will you? Recent history suggests you won't. 

People who retired 30 years ago tended to be much more prepared for retirement despite their lack of 401(k) plans. They were intended to be merely supplemental to employer-provided pension benefits. Is it possible that the Trump Administration should consider the benefits of incentives to get us back into a DB-biased world? Just asking.