New Trends in the 401(k) World

Shortly after the passage of the American Taxpayer Relief Act of 2012 (ATRA), Aon Hewitt did a pulse survey of more than 300 large employers (presumably from their client base, but the press release doesn't seem to specify) on 401(k) plans. Here were some of their key findings:

• 49% of respondents currently do not offer Roth provisions
• Of those, 29% are very likely or somewhat likely to add Roth provisions in the next 12 months (this would bring the percentage who do not offer Roth provision down to about 35% of the total)
• Of the new adopters, about 76% will add in-plan conversion (from traditional to Roth) features
• Approximately 53% of companies that currently allow Roth contributions but do not currently offer in-plan conversions will begin to allow them

Personally, I am pleased to see this trend. For the life of me, though, the only good reasons I can see to not offer both of these features are these:

• HR has too many other things on their plate and implementation of these is not a high enough priority to implement in 2013
• The company is particularly paternalistic and worries that because Roth accounts have earlier distributable events than traditional 401(k) accounts that participants will not use them for retirement
• Employees have not asked for them (I think this is not a good excuse because many employees will not have heard of the opportunity)
• Employers have not heard of these changes (shame on them, they should be reading this blog, of course)

The employer-sponsored retirement plan world has changed from one largely of employer responsibility to largely one of employee responsibility. For employees to someday retire, since very few who don't save in employer-sponsored retirement plan save elsewhere, those employees will need to begin saving at young ages and save responsibly and consistently. The more tools they have available to them, the more likely they are to do it, and that is good for our future.

CDHPs -- Perhaps I Was Always Correct

It's been more than one year since I wrote my not exactly seminal piece on Consumer Driven Health Plans (CDHPs). In it, I said that insureds forego lots of important medical care, not because they are making a well-considered consumer decision, but because they simply can't afford it. While I don't think anyone posted in the comment section of my blog, several experts told me privately how misguided my thoughts were. They told me how quality of care is increasing as consumers of medical care make wise choices.

Now we have a study published by the Rand Corporation working with researchers from Towers Watson and the University of Southern California. The way I read it, even if the quality of care, when care is sought, is improving, necessary preventive care is sought less often. In my opinion, it's because of one of these factors:

• Consumers can't afford to pay the costs.
• Consumers have experienced too many situations in CDHPs where they thought a particular test was covered by their plan as part of well care, but either it's not or it's not fully covered.
• Consumers have no idea if they can afford the costs, but dealing with the health plan's "Customer No Service" Department is just too painful.
• Their physician can't figure out whether the test is covered.

From the same study, reading from Figure 4, we see the following reductions in preventive care under CDHPs:

• 3.7% for Glucose Level
• 4.2% for Lipid Profile
• 4.9% for Cervical Cancer
• 2.8% for Mammogram
• 2.9% for Colorectal Cancer

I am not saying here that the CDHPs, in an of themselves cause these declines in preventive care, but there certainly does seem to be a correlation. Personally, I know that I am entitled to one physical per year under the employer-sponsored CDHP in which I participate. Frankly, I've been in a plan of that sort for most of the last 6 or 7 years. Of the tests listed above, some are fully covered by the plan, some are partially covered, and some don't seem to be covered at all. 

I don't recall which one it was, but for one of those tests, when I called the health plan, I was told that reasonable and customary (R&C) costs were covered. After they paid R&C costs, I was left with a $200+ bill.

Is my physician particularly expensive? I don't think so. He is an in-network provider. Am I in a particularly high cost of medical care geography? I'm pretty sure that's not the case. Did I do something wrong? Not that I can tell.

The good news is that I am in a pretty well-paid profession and I can afford my share of the costs of these tests. But, especially in a bad economy, many people can't. 

The evidence tells me that CDHPs are not working the way they are intended to. But, employer costs are coming down. So, we are probably stuck with these plans. Lucky us.

Distribution Patterns from 401(k) Plans

I read this morning about target date funds (TDFs) being designed to match up with patterns of distributions that participants are taking. The understanding of these patterns of distribution has been discerned from actual participant behavior. This is good.

Loyal readers though know that I rarely write about anything that's good. So, what's up? Why is John wasting his time on this topic?

As we all know, the past may not be the best predictor of the future. Over time, it may be, but not necessarily in the short run.

If we consider older workers -- for this purpose, I'm going to use this term to apply to anyone in the work force who is at least 50 years old. What do we know about them?

• Many of them have accrued benefits in defined benefit (DB) plans, even if the plans have been frozen or terminated recently.
• A reasonable number of them experienced the insane run-up in equity markets during at least part of the 90s. I don't think we will ever see anything like that again.
• Very few of them have much, if any, money in Roth accounts.

All of this is changing. The wave of the future is much more likely to be that participants have more money in Roth accounts, that they do not have the annuity stream from DB plans, and that very few have surpluses from a prolonged bull market.

As most of you know, currently, penalty-free distributions are generally available as early as age 59 1/2 and required distributions begin at age 70 1/2. When these provisions were put into the Internal Revenue Code, many participants were retiring before age 60 and few worked even close to age 70. Today, this is not the case.

It occurs to me that in the future, participants are going to need a more systematic means of distribution that can be delayed significantly. Part of it leads to new designs of TDFs. Part should lead to changes in the Code.

I plan to comment more on these topics in the future, but that's it for today.

President Names New Chair of SEC

President Obama has named a new Chair of the Securities and Exchange Commission (SEC). Mary Jo White is a litigator, head of the Litigation Department at Debevoise and Plimpton. Does this signal a directional shift for the Commission? Does this mean that future SEC rules will make it easier for plaintiff's bar to litigate matters?

Already, this is one of the biggest headaches for US publicly traded corporations. Issuers of proxies are now subject to say-on-pay, say on frequency, derivative lawsuits and many other relatively new breeds of pain. Many would say that this has stemmed from, first Sarbanes-Oxley and later Dodd-Frank.

For those who would like more information on Ms. White, here is her profile page on the Debevoise website.

The Perverse Result of More Progressive Tax Rates

It's no secret that the two major US political parties are at odds over federal income tax rates. President Obama and leading Democrats have made clear that they intend to raise taxes again on higher income Americans. Leading Republicans have implied that they will not let this happen and they seek a flatter tax structure.

Holding two of the legs of the voting stool (presidency and Senate), the Democrats would appear to have the upper hand. Let's focus on how this affects retirement. Who wins?

I think it is very possible that this will produce a perverse result. Here is why. When marginal tax rates on the highest earners increase, with those increasing rates tend to come hand-in-hand the following behaviors among that group:

• They save more on a tax-deferred basis
• They spend less
• They invest less

They are hoping that this is just part of a cycle and that their rates will come back down again soon. 

All this tends to point toward even further employer belt-tightening. This means smaller benefits and limited pay increases. The middle class is generally less able to withstand this because the people who fill that class just can't save as much. The highest earners, on the other hand, even if they can't make use of qualified plans have nonqualified plans in which to save on a tax-deferred basis. In essence, they will currently spend less and will have even more saved for retirement. At the same time, those who earn less than that will save less and have even more difficulty preparing for and saving for retirement.

I think this is just the opposite of what the Democrat Party intends. The result could be perverse indeed.

To Defer or Not to Defer, That is the Question

Last week, I wrote about the American Taxpayer Relief Act more commonly referred to as the Fiscal Cliff deal. While it avoided reversion to the pre-Bush era marginal tax rates for most Americans, it certainly included a lot of tax increases. Here we will focus on nonqualified deferred compensation (NQDC). Does it make more sens to defer or less sense to defer?

First, the withholding rate on supplemental wages in excess of $1 million in the aggregate increased to 39.6%. For supplemental wages up to $1 million, the withholding rate remains at 25%, What are supplemental wages? Generally, they are pay to an employee that is not part of a regular wage. They include overtime, bonuses, and distribution of nonqualified deferred compensation among other things. Ultimately, the taxes that a taxpayer pays are determined based on a number of factors, but the amount that they will see in a check for supplemental wages will decrease for particularly high recipients of supplemental wages.

Second, the OASDI portion of Social Security tax returned to 6.2% after being at 4.2% for a few years. This is the percentage of your paycheck that goes to Social Security on earnings not in excess of the Social Security Wage Base ($113,700 for 2013). The employer portion of OASDI remains at 6.2% of pay. For participants on NQDC plans, this is may be important because Social Security taxes are paid on NQDC generally in the year that such compensation is both vested and reasonably ascertainable. For most plans, that is the date when vested. For certain more complex plans such as DB SERPs, the amount may not be reasonably ascertainable until the participant terminates employment.

Third, the Medicare or HI portion of Social Security taxes has increased largely to pay for the ACA or ObamaCare if you prefer. For single filers with wages in excess of $200,000 or those filing jointly with income in excess of $250,000, the amounts above those thresholds will see an increase in HI tax from 1.45% of excess wages to 2.35% of excess wages. Additionally, there is a new 3.8% surtax on investment income such as capital gains from the sale of stock.

So, how do you know whether to defer or not to defer? It's a difficult question and the math is not as easy as we might like. Generally, the higher the marginal tax rate that you are paying, the more useful tax deferral is. Of course, there are many other factors that may influence your decision including your view of future tax rates, your need for the money in the short term, the investment return you can achieve and other factors that may be particularly germane to you as an individual.

Best of all will likely be compensation deferred in qualified plans such as 401(k), other defined contribution, and defined benefit if you are fortunate enough to have those opportunities.

In any case, for high earners, the new tax rates are more confiscatory than were the old ones, but your guess is as good as mine with respect to where they will be in the future.

We Have a Fiscal Cliff Deal

It had to happen. If it didn't, the sun might not have risen. Perhaps it's what the Mayans anticipated so many years ago -- the fiscal cliff. Well, through the last-ditch efforts of Congress (you do know that a collection of baboons is called a congress, don't you?), we have 157 pages of legislative contortion that keeps the country from plunging off that cliff.

Who gets helped? Who gets hurt? Well, they say that if nobody is happy, then there really was compromise. In this particular case, the compromise was a combination of tax cut extenders and a few spending cuts. Most of what's in the bill doesn't matter to my typical reader. In fact, most of it doesn't apply to any reader that I know. But, since you're here and reading, I'll let you in on a few things that might.

• FICA taxes (the OASDI part) are going back up to 6.2% of pay up to the wage base. For those who are counting, that's a 2% additional tax compared to last year on the entire income of most working Americans. But, if we kept it at 4.2% of pay, Social Security was going to run out of money really quickly.
• Most Americans have no increase in their marginal tax rates. Unless you are (depending upon your filing status) a single person with adjusted gross income (AGI) in excess of $400,000, a head of household with AGI more than $425,000, or a couple filing jointly with AGI exceeding $450,000, you still benefit entirely from the Bush era cuts in marginal income tax rates.
• If you are fortunate enough to be a beneficiary of the estate of someone who is unfortunate enough to die, estate tax rates are higher than they have been the last few years, but not as high as they were prior to 2001.

These were all considered to be tax increases by those who were worried about counting tax increases versus spending cuts. But, then there's this beauty for people who are wondering where the spending cuts are coming from. The ability to convert traditional IRA, 401(k), 403(b), etc. accounts to the Roth variety has been made permanent, or at least until a future law makes this ability disappear. 

This is a savings? Of course it is. Readers of this blog know of my dislike for the required methodology used to score bills by the Congressional Budget Office (CBO). They look at the next ten years on a static economic basis. Since you have to pay taxes on the converted amount when you convert your Roth, and the taxes that you would have paid upon retirement on the traditional account would often have not been paid for more than years into the future, this is scored as a money-saver.

The message here is that when you read in the media that there are spending cuts in this bill, take it with a grain of salt.

Oh yeah, there are also tax cut extenders for some of the usual suspects: Hollywood, NASCAR, and green energy among them. 2013 is off to a rousing start.