Friday, February 23, 2018

Are You Better Off than You Were 20 Years Ago?

Nearly 40 years ago, Ronald Reagan asked voters if they were better off than they were four years earlier. And, that was the beginning of the end for Jimmy Carter's reelection hopes. So, without trying to end anything for you, I ask if you are better off from a retirement standpoint than you were 20 years ago.

For Americans as a group, I think the answer is a clear no. Our retirement system has been broken by the momentum that has gathered around the 401(k) plan. After all, when Section 401(k) was added to the Internal Revenue Code in the Revenue Act of 1978, it was never intended to be a primary retirement vehicle. In fact, it was a throw in that even among those who were there, there doesn't seem to be much agreement on why it was thrown into the Act.

When it was, however, defined benefit (DB) pension plans were in their heyday. People who were fortunate enough to be in those plans then are now retired and an awful lot of them are living very well in retirement. On the other hand, people who are now retiring having been in 401(k) plans only have their retirement fates scattered all over the place. Some are very well off, bit others are essentially living off of Social Security.

Let's consider where those people went wrong. For many, when they first had the opportunity to defer, they chose not to. They had bills to pay and they just couldn't make ends meet if they didn't take that current income. By the time they realized that they should have been saving all along, they couldn't catch up.

For others, they were doing well until they lost a job. Where could they get current income? They took a 401(k) distribution.

Yes, I am very well aware that the models show that people who are auto-enrolled and auto-escalated in a 401(k) plan with a safe harbor match will fare quite well. Those models all assume no disruptions and constant returns on account balances of usually around 7%.

Let's return to reality. The reality is that young workers are (likely because of all the campaigns telling them to do so) deferring liberally when they start in the workforce. The problem is, and I get this anecdotally from young workers, that more of them than not reach a point where they just can't defer at those levels any more. They get married, buy a house, and have kids, and the financial equation doesn't work. So, they cut back on deferrals. I know a number who have gutted one or more of their 401(k) plans in order to buy a house. The fact is that it's not easy to defer, for example, 10% of your pay into your 401(k), another 5% into your health savings account (HSA), and save money for a down payment on a house.

Where were we 20 years ago? For many Americans, they were about to be getting those notices that their DB plans were getting frozen. Congress killed those DB plans. The FASB killed those DB plans.

When I got into this business in 1985, most (not all) corporate pension plans were being funded responsibly. And, this status was helped, albeit for only a year or two by the Tax Reform Act of 1986 (shortening amortization periods). One of the big keys, and this will be understood largely by actuaries, is that we had choices of actuarial cost methods. My favorite then and it would be now as well for traditional DB plans is known as the entry age normal (EAN) method. The reason for this is that under EAN, the current (or normal) cost of a plan was either a level cost per participant (for non pay-related plans) or a level percentage of payroll for pay-related plans. Put yourself in the position of a CFO -- that makes it really easy to budget for.

But Congress and the FASB knew better. In the Pension Protection Act of 1987 (often referred to OBRA 87 because it was one title of the Omnibus Budget Reconciliation Act), we had it imposed on us that we must perform a Unit Credit (another actuarial cost method) valuation for all DB plans. And, in doing that Unit Credit (UC) valuation, we were given prescribed discount rates. At about the same time (most companies adopted what was then called FAS 87 and is now part of ASC 715), DB plan sponsors also had to start doing a separate accounting valuation using the Projected Unit Credit (PUC)  (Unit Credit for non-pay related plans) actuarial cost method. Most of those sponsors found that their fees would be less if they just used these various unit credit methods for their regular valuations as well and we were off and running ... in the wrong direction.

You see, PUC generally produced lower funding requirements than EAN and the arbitrary limits on funding put in place by that second funding regime known as current liability (the UC valuation) and most DB plans had what is known as a $0 full funding limit. In other words, they could not make deductible contributions to their DB plans during much of the 1990s. And, it stayed that way until prescribed discount rates plummeted and there were a few years of investment losses.

What happened then?

CFOs balked. They had gotten used to running these plans for free. Suddenly they had to contribute to them and because the funding rules were entirely broken, the amounts that they had to contribute were volatile and unpredictable. That's a bad combination.

So, one after another, sponsors began to freeze those DB plans. And, they did it at just the time that their workers could least afford it.

For all the data and models that tell us that it should be otherwise, more people than ever before are working into their 70s, generally, in my opinion, because they have to, not because they want to. As a population, we're not better off in this regard than we were 20 years ago In fact we are far worse off.

Even for those people who did accumulate large account balances, many of them don't know how to handle that money in retirement and they don't have longevity protection.

We need a fresh start. We need funding rules that makes sense and we need a plan of the future. It shouldn't be that difficult. I'd like to think that my actuarial brethren are smart people and that they can design that cadre of plans. They'll be understandable, they'll be portable as people change jobs, they'll have lump sum options and annuity options , and they'll even have longevity insurance. They'll allow participants the ability to combine all those in, for example, taking 30% of their benefit as a lump sum, using 55% for an annuity from the plan beginning at retirement, and 15% to "buy" cost-of-living protection from the plan.

That's great, isn't it? Even most of the 535 people in Congress would probably tell you that it is.

But those same 535 people don't really understand a lick about DB plans or generally about retirement plans (there are a few exceptions, but very few). In order to get that fresh start, we need laws that will allow those designs to work.

We surely don't have them now.

Over the years, Congress has punished the many plan sponsors because of a few bad actors. If 95% of DB plans were being funded responsibly, then Congress changed the funding rules for 100% of plans to be more punitive because of the other 5%.

Isn't it time to go back to the future to get this all fixed?

Let's kill the 401(k) as a primary retirement plan and develop the plan of the future. It could be here much sooner than you think.

Friday, February 2, 2018

How Big Does Your ROI Have to Be? You Can Get It Here

Let's make believe it's 2018. Let's further make believe that the Tax Cuts and Jobs Act (TCJA) or whatever it's long-winded name turned out to be was signed into law late last year. And, let's finally make believe that you hold a corporate position where you get to weigh in on corporate investments and deployment of capital.

Just how big of a return on investment do you need to be able to project in order to pull the trigger?

8%? 10%? 12%? 15%?

For most of you, I'm guessing that I've finally surpassed or at least hit your target. You'll definitely want to read on. For those that need a bigger number, give me a chance. But, I didn't want to scare away those people who think that really big numbers are only found in Fantasyland.

For those of you that really want to get into the technical details, I'm going to refer you to an excellent piece written by my Partner, Brian Donohue. Some of you may not want to get into that level of gory detail and you just want the big picture and a summary to convince you, you've come to the right place.

First off, you need to sponsor a defined benefit (DB) pension plan. It's fine if it's of the cash balance or some other hybrid variety. So, let's suppose that you do because if you don't and you have no plans to, unless you just really love my writing or just have a strange desire to find out what you are missing out on, you can probably stop reading now.

I don't want to put this in terms of dollars because if I talk about billions and you are a $100 million company, you may not think this is for you. And, conversely, if I talk about millions and you think millions go away in rounding, you won't think it's for you. So, let's talk about units.

Suppose your DB plan is fully funded on a Schedule SB basis. In other words, your funding target and your actuarial value of assets both equal 1000. Then your minimum required contribution, generally speaking, is equal to your target normal cost, probably not a big number compared to what we are talking about here.

Despite not having to, contribute 200 units. Go ahead. Do it. Trust me. I wouldn't sell you snake oil.

Here are your benefits from having done so before September 15, 2018 (assuming calendar year plan year and tax year):


  • The 200 units are tax-deductible under Code Section 404 for 2017 when your corporate marginal tax rate was likely 35% (yes, there are unusual circumstances where they may not be or where the deductions may not be of value to you, but for most sponsors, this is the case) as compared to 21% beginning in 2018. Savings of 14% of 200=28 units.
  • Your PBGC variable rate premiums may come down by as much as 8 units, But that could be as much as 8 units per year for multiple years (let's call it 5 years for sake of argument). Savings of 8 units times 5 years=40 units.
That's 68 units of savings on a 200 unit deployment of cash. That's 34%.

Now, I'm not going to claim that your ROI here is actually 34%. Yes, you will contribute these amounts more than likely in future years and when you do, you will take a tax deduction. But, you'll take it in the future (you remember time value of money) and you'll only get a 21% deduction when you do. And, yes, you may not get those full PBGC savings and some of them will be in the future, but your savings are likely to be significant.

And, then there is the other really key benefit -- your plan will now have a surplus on a funding basis meaning that you almost certainly don't have to contribute and deal with volatility of minimum required contributions in the near future.

I'd be doing you a disservice, of course, if I didn't give fair consideration to the downsides and perceived downsides of this strategy. So, I'm going to shoot straight with you.

Yes, you will have 200 units of cash tied up with no immediate means of accessing it. However, it's getting you a pretty good and rapid ROI, so in most cases, I think you'll get over that one.

Pension surplus is considered to be a bad thing. In fact, prevailing wisdom is that pension surplus is worth only pennies on the dollar. Well, sometimes prevailing wisdom shouldn't prevail.

If your DB plan is ongoing, this is just advance funding, plain and simple. It's money that you would have to contribute and the future when you could take your deductions at a 21% marginal tax rate.

If your DB plan is frozen, the argument is a little trickier. But, for most sponsors, if you do have a frozen plan, the cost to terminate is likely going to exceed your funding target. In fact, it's likely to exceed your funding target by a fair amount. So, those 200 units will be put to use.

But, let's take the extreme scenario where your investments do well, interest rates rise, and those 200 units really start to look like trapped surplus. 

Do you sponsor a defined contribution (DC) plan? It may not fit your current DC strategy, but generally speaking, your DB surplus upon termination can be used to fund a "qualified replacement plan" (think profit sharing or non-elective contributions) for up to seven years. So, in that case, you would be getting an advance deduction for future DC contributions.


Yes, I've simplified things and there are potential tax and legal issues here, so I leave you with this:

Nothing in here should be construed as tax or legal advice which can only be obtained from a qualified tax or legal professional. If you need tax or legal advice, you should consult such a professional. And as with any strategy of this sort, your mileage may vary.



Thursday, January 4, 2018

Everybody Must Get Sued

I logged into my social media this morning and I noticed a pervasive theme. LinkedIn, Facebook, Twitter -- the trend in their highlights or whatever the particular site is calling that section is that somebody is getting sued. In fact, looking at my top highlights on each of those sites, more than 50% of those highlights is that somebody is suing somebody else. That's a frightening sign of the times.

Suppose instead of those sites, there was a site called BenefitsGram or SnapCompensation, what would they look like? Well, there are sites that are a little bit like that -- there's Plan Sponsor's News Dash and Benefits Link's Benefits Buzz, a pair of news consolidator sites. And, when I look at what's trending there, it's the same -- everybody must get sued.

So, why am I writing about this here?

In these days where many of the pundits talk about risk management and de-risking, is there a bigger risk than getting sued? For many companies, there may not be. A big enough lawsuit can put one of them out of business. I could certainly name some where that has happened (I'll skip that part though as I'm sure you have access to Google search as well).

In my world, it's happening around benefits and compensation programs on a more than daily basis. Somebody is getting sued. And, yes, I will agree, many of those lawsuits are frivolous. And, even among the ones that have some substance to them, an awful lot of those should fail on the merits.

The sad part, though, is that among those that should fail on the merits and even those that should succeed, almost all of them could have been avoided.

Defending a lawsuit is expensive. Even if you win, you probably paid an attorney a lot of money to defend you. And, that attorney likely convinced you (rightfully so in most cases) that you needed an expert witness or two or three on your side and you paid them a lot of money as well. So, even if you won, you lost.

What does real winning look like? It looks like not getting sued in the first place. On the contracts side, the key seems to be to write 100 page license agreements (or similar documents) that you know your customers won't read before they sign off on something that is so one-sided that they have no rights at all. On the benefits and compensation side, it's not so simple. Usually, you have to have things like plan documents and those documents have lots of legal requirements to comply with all the laws that Congress touts, but that are festered with so much junk that makes for great PR, but no sense at all.

So, you write those documents or get counsel to do that for you (probably a better idea). And, back in Section 14.23 of one of the documents, somebody wrote a really long and confusing paragraph. and, they left off an s at the end of a word that would have changed a singular to a plural. Voila! Somebody finds that the s is missing and decides that was always intended and not having that s will entitle an entire class of potential plaintiffs to double their benefits or more.

Will they find a court that will allow them to strike the first blow? Do they win at the District Court level? If they do, you have already spent a lot of money and if you want to appeal, you'll have to spend  a lot more.

So, what's the message here? Do everything you can to make sure that your intent of each of your plans is clear. Explain with examples. While I don't often praise IRS and Treasury for their mastery of the English language, they are well known for using words such as "the provisions of this paragraph (b) can be illustrated by the following examples" and then they give maybe five examples to make crystal clear what they intended.

You can too.

And you should.

But you probably haven't.

And neither have your counterparts at thousands of other companies.

So, here's your checklist:


  1. Address the litigation risks in your plans.
  2. Take steps to fix and problems that you have uncovered.
  3. If you do get sued, make sure your counsel finds great expert witnesses for you.
Otherwise, everybody must get sued ... with apologies to Bob Dylan and Rainy Day Women #12 and 35.

Tuesday, December 12, 2017

Wake Up and See the Light, Congress!

Congress has a once-in-a-generation opportunity. Since its first major overhaul in 1922, Congress has seen fir to make earth-shaking changes to the Internal Revenue Code (Code) once every 32 years. 1922. 1954. 1986. And, while it seems that they may be one year early this time, they are pitching tax reform once again.

The concept of qualified retirement plans as we know them today comes from the Employee Retirement Income Security Act of 1974 (ERISA) signed into law that Labor Day in 1974. Since that time, there have been relatively few changes to the Code affecting retirement plan design. And, frankly, most of them have come on the 401(k) side. In fact, Section 401(k) was added to the Code after ERISA and since then, we have been blessed with safe harbor plans, auto-enrollment, auto-escalation,Roth, and qualified default investment alternatives (QDIAs). Over the same period, little has been codified or regulated to help in propagating the defined benefit plan -- you know, that plan design that has helped many born in the 40s and early 50s to retire comfortably.

Isn't this the time? Surely, it can be done with little, if any, effective revenue effects.

Since ERISA, there have been really significant changes in defined benefit (DB) plan design including the now popular traditional cash balance plan, the even better market return cash balance plan, pension equity plan, and less used other hybrid plans. And, DB plans have lots of features that should make them more popular than DC plans, especially 401(k) plans.


  • Participants can get annuity payouts directly from the plan, thereby paying wholesale rather than the retail prices they would pay from insurers for a DC account balance.
  • Participants who prefer a lump sum can take one and if they choose, roll that amount over to an IRA.
  • Assets are professionally invested and since employers have more leverage than do individuals, the invested management fees are better negotiated.
  • In the event of corporate insolvency, the benefits are secure up to limits.
  • Plan assets are invested by the plan sponsor so that participants don't have to focus on investment decisions for which they are woefully under-prepared.
  • Participants don't have to contribute in order to benefit.
But, they could be better. Isn't it time that we allowed benefits to be taken in a mixed format, e.g., 50% lump sum, 25% immediate annuity, 25% annuity deferred to age 85? Isn't it time that these benefits should be as portable as participants might like? Isn't it time to get rid of some of the absolutely foolish administrative burdens put on plan sponsors by Congress -- those burdens that Congress thought would make DB plans more understandable, but actually just create more paperwork, more plan freezes, and more plan terminations?

Thus far, however, Congress seems to be missing this golden opportunity. And, in doing so, Congress cites the praise of the 401(k) system by people whose modeling never considers that many who are eligible for 401(k) plans just don't have the means to defer enough to make those models relevant to their situations.

Sadly, Congress prefers to keep its collective blinders on rather than waking up and seeing the light. Shame on them ...

Thursday, December 7, 2017

Focusing on the Pension Part of the Deal

Let's suppose you're on the finance side of a business. That business is buying a company and you learn that the company that you are acquiring has one or more defined benefit (including cash balance) pension plans. What do you do now?

Pension plans and the finances associated with them are among the most confusing and misunderstood elements of a deal like this.The rules are unnecessarily complex and are often misunderstood even by people that you might be inclined to engage as experts. Cash flow requirements do not align well with financial accounting charges and not knowing the right questions to ask could seriously impede your ability to get the answers that you need.

So, how can I help?

Among the really nice things about pension plans is the amount of information that is publicly available on each of them. You see, in its infinite wisdom, Congress and the agencies that Congress has entrusted to regulate pensions have deemed that a myriad of such information has to be disclosed every year for each plan. In unknowing hands, that information is just that -- information. In the right hands, however, it's a veritable goldmine.

As a senior finance person, what do you need to do?


  1. Identify all of the plans that you might be (will be) acquiring.
  2. Identify what measures are important to you (e.g., cash flow, financial accounting expense, government disclosures, volatility, loan covenants).
  3. Identify your constraints (e.g., available cash to use for pensions, funded status triggers to loan covenants).
  4. Identify your goals with regard to the plans.
Notice that I didn't mention plan documents, participant census data, plan asset statements, or anything else that you thought you needed to provide. This is where that goldmine comes in.

I call your attention to a recent situation where we had just the information in 1. through 4. above. The goals were fairly simple and included roughly these:

  • Help us to understand the amount of cash necessary to pay for the plan(s),
  • Tell us what is not being done optimally, and 
  • Help us to find ways to optimize these plans on a path to termination.
Our client now has a 10-year forecast of cash flow requirements under multiple scenarios. They understand what has not been done optimally over the last 10 years or so. And, they now have a strategy all set to go so that when they do pull the trigger and finish their deal, they'll be putting their pension dollars to optimal use.

This is a place where off-the-shelf, cookie-cutter solutions don't work. Every plan is different. Every plan has different thresholds. Every company is different. Every company has different resources.

But what makes every company the same is that every company needs a solution that is customized to their situation.

Tuesday, November 21, 2017

Cookie Cutter Doesn't Cut It

I was on the phone with a sophisticated client a few days ago. She remarked that the solution she was looking at was just pulled off the shelf and could equally apply to any [company]. She said that was bad consulting. I have to agree. Thankfully, that consulting was not ours.

When I started in the business, back in prehistoric times, the modus operandi that many of us were introduced to included answer the phone, do the work, record your time, and someone will bill the client for it. Complaints appeared to be limited.

Things got more complex. The booming economy in our business created by the Reagan-era bull markets and the Tax Reform Act of 1986 was a veritable full employment act for consulting actuaries. Employers of those actuaries needed all the quality staff they could find and clients needed all the support they could get.

Things changed. As processes got automated and later, as companies began to exit the business of sponsoring pension plans, this once highly valued actuarial service became more of a commodity. Whether it was true or not, consulting actuaries who could deliver actuarial valuations were viewed as being a dime a dozen.

How did the best differentiate themselves? They began to provide more and more customized solutions. They began to understand the client's business needs. There was a sudden shift in the order of necessary skills. The key ability of being able to do things was replaced in the pecking order by the ability to listen and then to thoughtfully react.

Somewhere around the same time, our society seemed to become far more litigious. The answer to many problems became finding some other party who could be found to be at fault and exacting a price from that party. Some made the observation that in response to this, there were a number of consulting firms that developed solutions that everyone should bring to each of their clients. In fact, I can recall professional friends of mine complaining that they needed to be able to "check the box' for each of their clients even if they felt as if that meant they were providing less than the optimal answer. In other words, they were being encouraged, or even required to pull the answer off the shelf or some might say, to deliver a cookie cutter solution.

Put yourself in the corporate shoes. Your adviser that you have worked with for years brings you a solution that they label best-in-class. A few days later, you find yourself at a gathering with your peers from other local companies. Alas, they have all been brought the same solution.

How is that possible? The companies aren't the same. Their plans aren't the same.

It's then that you remember that you had agreed, based on a referral, to a meeting the next day with some consultant you had never heard of. You wondered if she would try to sell you on the same best-in-class solution.

She didn't. After the initial niceties, she asked you a bunch of questions. And after each question, she listened to your answer and reacted accordingly by asking a follow-up, more probing question. She remarked that she was surprised that you weren't pursuing [pick your favorite strategy to fill in the blank] instead of the not best-in-class one that your longtime adviser had brought you.

You wanted to to business with her, didn't you?

Friday, November 3, 2017

Proposed Tax Bill Would Change the Face of Executive Compensation

Yesterday, Representative Kevin Brady (R-TX), Chair of the powerful House Ways and Means Committee, rolled out the Republican tax reform proposal. And, while no tax bill in my lifetime or likely anyone else's lifetime has made it through the legislative process unscathed, the draft bill fashioned as HR 1 certainly provides an indicator of where we may be headed.

Much seems completely as expected. We knew about the slimming to four tax brackets. We knew about the narrowing of deductions. We knew that some of the more heavily-taxed states would feel the pain of restructuring. What we didn't know and what frankly came as a surprise to me and to others that I know would completely change the face of executive compensation in the US. Honestly, on its surface, these proposed changes look to me as if they they had been constructed by Democrats. It wouldn't surprise me if these changes had been pre-negotiated, but that's entirely speculation on my part.

So, what's the big deal?

There are two extremely significant proposed changes according to my initial reading.


  1. The draft would amend Code Section 162(m) (the $1 million pay cap) to eliminate the exemption for performance-based compensation. In addition, that section would be amended to cover the Chief Financial Officer in addition to the Chief Executive Officer. 
  2. Code Section 409A would be repealed (you thought that was good news, didn't you?) and replaced with a new Code Section 409B. Essentially, 409B as drafted would apply the much more stringent taxation upon vesting rules that have previously applied generally only to 457(f) plans. 
162(m) Changes

Section 162(m) was added to the Internal Revenue Code by the 1993 tax bill. Widely praised at the time as a way to limit executive compensation, the exemption for performance-based compensation turned out to be a far bigger loophole than had been imagined. Many companies saw this as a license to offer base pay of $1 million to their CEO while offering incentive pay (some only very loosely incentive based) without limits while taking current deductions.

That would change. 

My suspicion is that companies would return to paying their top executives as they and their Boards see fit, but with the knowledge that particularly high compensation whether performance based or not would not be deductible. Additionally, so called mega-grants and mega-awards would likely become much rarer as the cost of providing them would no longer be offset by tax savings.

409B

The ability to defer compensation has long been a favorite of high earners. The requirement to defer compensation has also been considered a good governance technique by many large employers (for example, a number of large financial services institutions require that percentages of incentive compensation be paid in company stock and that receipt must be deferred),

Much of this would go away as very few people have the ability or desire to pay taxes on large sums of money before they actually receive that money.

What Might Happen If the Bill Passes

Nobody really knows what might happen. But since this is my blog, I get to guess. Here, readers need to understand that there is no hard evidence that what I say in this section will happen, but it seems as if it could.

The draft of HR 1 appears to keep tax-favored status for qualified retirement plans. That's important because qualified retirement plans are a form of deferred compensation with some special rules and requirements attached. What this means is that to the extent that an individual would like to defer compensation on a tax-favored basis, he would need to do it through a qualified plan.

However, qualified plans need to be nondiscriminatory; that is, they must (not an exhaustive list):
  • Provide benefits that are nondiscriminatory (in favor of highly compensated employees)
  • Provide other plan elements sometimes known as benefits, rights, and features that are nondiscriminatory
  • Cover a group of employees that is nondiscriminatory
There are techniques by which this can be accomplished in a currently legal manner, but they are not simple. It would not surprise me to see more interest in these techniques.

As I said at the beginning, I don't expect this bill to pass as is. But, these particular provisions written by Republicans should not draw ire from Democrats. We'll see where it goes.