Accounting Issues in Converting a DB SERP to a DC SERP

Here is an article that I was involved in writing, but that my prior employer chose to list other authors. In any event, I still know about this material and could help someone out. Here is the article from the corporate web site:

http://tinyurl.com/28khn96

Pre-Boomers Want Retirement Income Stream

In a poll sponsored by Nationwide Financial and conducted by Harris Interactive, 85% of those age 18-44 support a modification to the current 401(k) structure that would provide a guaranteed annuity stream from 401(k) plans, as compared to 77% of the total adult population. This suggests that as participants get closer to retirement, they are more likely to want a lump sum payment. To me, this is counter-intuitive.

I do not have the exact wording to the question that was asked.

As most surveys of this sort are, the poll has at least a bit of a self-serving element to it. Employer matches would not be available for loans or hardship withdrawals and plans would provide annuities via the purchase of fixed income deferred annuities (something that Nationwide presumably sells ... at a profit).

How big would the insurer's profit be? Do the survey respondents understand that they would be paying for that insurance? It's food for thought, but IMHO, it's a long way away.

New DOL Target Date Fund Rules

In today's Federal Register, the DOL published new rules for target date funds in qualified defined contribution plans. Briefly, target date funds (TDFs) are pre-mixed funds of funds usually put together by mutual fund providers. They allow a participant to select an estimated or targeted retirement date (usually in 5-year increments) and put their money in a fund that uses a glide path (investment allocation policy) that becomes more conservative as a participant approaches their targeted retirement date. TDFs became exceedingly popular as the Qualified Default Investment Alternative (QDIA) of choice after passage of the Pension Protection Act of 2006.

You can find the DOL guidance here: http://www.ofr.gov/OFRUpload/OFRData/2010-29509_PI.pdf

Key guidance in the rule includes the following:

• Fiduciaries are relieved from certain fiduciary responsibilities in defined contribution plans if they follow the rules.
• Plan administrators must furnish participants and beneficiaries with certain information related to each available investment under the plan.
• That information must include:
• A narrative explanation of the glide path and a description of the point at which the TDF will reach its most conservative investment allocation. This is key in understanding whether the purpose of the particular TDF is to get participants to retirement or through retirement.
• A graphical illustration of the TDF's glide path.
• An explanation of the relevance of the TDF date; e.g., for a 2030 fund, what does the "2030" mean?

Again, this is probably a step in the right direction for TDFs in reaction to the precipitous fall in the value of TDFs in late 2008 and early 2009. But, the reasoning is wrong. Of course, TDFs can lose money. All investments can. The point is that retirement plan participants need to understand the decisions that they must make. This is good information, but if they don't understand that this is an investment that is designed to increase in value, but that could decrease in value, then we have gotten nowhere. 

Americans need to be more financially educated. Savvy is a good goal, but educated is a necessity. It's nice that we learn about the explorers in school (Columbus, Magellan, etc.), but wouldn't it be nice if we educated our students in financial topics as well? It's never too early to start, but for many workers, it's far too late. For them, perhaps the best they can do is to follow the sage (or not so sage if you prefer) advice of Ron Popeil (he of infomercial fame): "Set it and forget it." Unfortunately, there is his follow-up line: "Wait, there's more."

Brits Love Their Pensions

In a survey by Canada Group Life Insurance, the most important employee benefit (according to employees) in the UK is a good pension. In second place is a good holiday/vacation policy. According to Canada Group,  "In a tough marketplace where employers are working hard to retain their top talent, they need to close the difference between the benefits they offer and what employees actually want."

Perhaps Americans love their pensions, too, or they would if they had them.

IRS Gives Additional Time for Roth Amendments and Lots of Other Roth Guidance

Note:  You can find my earlier blog post on the subject here:
http://johnhlowell.blogspot.com/2010/11/in-plan-roth-conversions.html


In Notice 2010-84, the Internal Revenue Service provided lots of needed guidance on in-plan (withing a 401(k) plan) Roth conversions (converting traditional 401(k) money to Roth money). Probably the most important guidance extended the deadline for adopting conforming plan amendments until the close of the 2011 plan year. For companies that may have been struggling to get these amendments done in time, this is very good news.

You can find the text of the Notice here: http://benefitslink.com/IRS/notice2010-84.pdf

Here is a summary of some of the other key guidance contained in the Notice:

• In order to be eligible to do an in-plan Roth conversion, a participant must be at least age 59 1/2, dead or disabled, or receive a qualified reservist distribution.
• Plan loans are not considered new loans.
• Spousal consent is not required.
• Roth conversions may be allowed by a plan even if the plan does not allow in-service distributions. If you are a participant who is at least 59 1/2, this could be very valuable.
• For 2010 conversions only, the participant can make an irrevocable election to not include that income for 2010 tax purposes, but split it evenly between his or her 2011 and 2012 tax years. This could be crucial for tax planning. Note, however, that employers will not withhold for in-plan Roth conversions. So, if you are doing a large in-plan conversion, you need to be careful to not under-withhold.

Does Your Company Have an ESOP? Should It?

Does your company sponsor an ESOP (employee stock ownership plan)? Should it? According to research by the National Center for Employee Ownership (NCEO), closely-held companies that sponsor ESOPs are more successful (higher sales and profits) than those that do not. Is this a causal effect? Or, on the contrary, are more successful companies simply more able to sponsor an ESOP?

In any event, here are a few tidbits about ESOPs:

• They are qualified defined contribution retirement plans and are subject to all of the attendant rules plus a few that relate only to ESOPs
• ESOPs can be leveraged; i.e., they can be financed partially through loans
• Over-leveraging an ESOP can be disastrous. Companies that may have a decreasing population need to be careful to not borrow too much. ESOP lenders will almost always try to get the plan sponsor to borrow as much as possible.
• ESOPs can be a great tool for succession planning or estate planning (see, for example, Section 1042 exchanges).
• Nondiscrimination testing for ESOPs can be far more restrictive than for other qualified retirement plans.
• Private companies that sponsor ESOPs will have a relatively continual repurchase liability (to buy back shares from terminating/retiring employees). It is important that they have a good handle on this liability and associated cash flow requirement.

So, should you have an ESOP? I don't know. It takes careful analysis, and that analysis is different for each company.

Rollovers: The Where From and The Where To in a Handy-Dandy Chart

Are you confused by what moneys you can roll over to where? Can you roll your 457 money into an IRA? How about your 403(b) money? Can you roll your Roth 401(k) into a traditional IRA? Do you know? Does anybody know?

The IRS has been good enough to tell us and the 401(k) Help Center has given us a handy-dandy chart. You can view the chart here: http://www.401khelpcenter.com/pdf/Rollover_Chart.pdf

If you're not sure of the correct answers for you, it's worth taking a look.

Think Tank Recommends Decreases in Tax-Favored Retirement Contributions

The Bipartisan Policy Center (supported by the Economic Policy Institute) recently unveiled a proposal, that among other things, would decrease the total amount that could be contributed to tax-favored, or qualified, retirement plans to $20,000 or 20% of pay, whichever is smaller. (You can read the full report here: http://www.bipartisanpolicy.org/sites/default/files/FINAL%20DRTF%20REPORT%2011.16.10.pdf . The section referenced above can be found on page 39 of the 140 page document.)

This would serve to make many Americans even less prepared for retirement than they are currently. Companies with defined benefit plans and defined contribution plans (yes, there still are a few) could be limited in their contributions. Even participants in 401(k) plans would often see their deferrals reduced.

This is lunacy (assuming that the income tax is continued). In a day where 'leakage' (losses in 401(k) accumulation due to loans, hardship withdrawals and discontinuity in employment among other things) is commonplace, workers who would like to retire someday need to be able to catch up during good times. The Congress and President saw this in 2001 with the passage of EGTRRA in 2001 which allowed for "catch-up" contributions for those at least age 50.

It seems to this writer that under that structure, the two groups of people who will likely be able to retire are those with ultra-high income and those with very low income. The first do not have costs that tend to obliterate their incomes (unless they choose to live that high off the hog). The latter will live off of Social Security and Medicare or Medicaid and have a lifestyle similar to what they had when they were working (or not). For the rest, costs like education for their children, energy, housing, and taxes will diminish their abilities to save for their own retirement. Being deemed redundant in the workplace may result in layoffs that further cut into any savings they may have.

This proposal is akin to classism -- a stratification of classes where in this case, the true upper class are fine, the lower class may be better off in retirement and the middle class will work forever (if they can) in order to not become the lower class.

VERY Temporary Doc Fix Passed

The House has approved a bill that delays by one month, scheduled cuts in Medicare payments to doctors (Doc Fix). Note that this still needs to go through the Senate and is only a 1-month delay.

With Regard to Benefits and Compensation, Whither Goeth the 112th Congress?

We, the people, have recently elected a new Congress. Unless you have been hiding under a rock, or perhaps a pile of rocks, you know that the Republicans have taken control of the House of Representatives and that the Democratic majority in the Senate is probably subject to filibuster on any issue with which the Republican leadership has really significant disagreement. Finally, the Republicans seem particularly united on what they consider to be their key issues.

So, the general thoughts are that Health Care Reform will get repealed, retirement legislation will be more employer and less union friendly, and compensation restrictions will largely be gone. Hold on! We don't have a Republican President. The Republicans in Congress can say all they like and they can try for all they want, but likely the best they can do during the 112th Congress is to try to work with the Democrat Party to reach happy compromise.

Current thoughts include these:

• The Republicans will use their majority in the House and their filibuster ability in the Senate to block funding for enforcement of Health Care Reform. While this sounds good to those who would like to see Health Care Reform disappear, my opinion is that doing this will alienate many swing voters and guarantee a Democrat return to majority in the 2012 elections.
• George Miller, Chair (until January) of the House Health, Education and Labor Subcommittee, will not have the influence that he has had with a Democrat majority. His personal agenda, focused on what some would consider over-disclosure to participants, is likely to fall by the wayside. Thus, all disclosure projects in the next two years will need to come through the DOL rather than through Congress.
• As a group, the Republican Party tends to intervene much less in corporate compensation decisions than the Democrat Party, but this is a hot button for the President. Don't expect the President to give in on this one, he has referred to Wall Street "fat cats" enough times that we can be sure that he will not sign any bill that lifts restrictions on executive pay.
• Where marginal tax rates will be in 2011 will influence benefits decisions. I have my suspicion that the EGTRRA (Bush) tax cuts will remain for all taxpayers through 2012, but I sure wouldn't bet my life on it.

So, whither goeth Congress on benefits and compensation issues in the short term? I think the answer may be nowhere.

Retirement Aspirations Around the World

The HSBC group conducted a similar study, "HSBC Future of Retirement." It surveyed over 11,000 people around the world and published a thorough analysis about how individuals in various cultures perceive a typical retirement. Among its findings:

* Canadians view their later years as a time of reinvention, ambition and close relationships with friends and family.

* Americans view their later years as a time for opportunity, new careers and spiritual fulfillment, but are less focused on family or health than are people in other countries.

* The French view these years as a time of dreams and aspirations, but also as a time of worry, and they are concerned about being a burden to their families.

* The British view later life as a time of self-sufficiency, independence and personal responsibility, counting on neither government nor family to care for them.

* Brazilians view later life as a time for slowing down, relaxing and spending time with their families, relatives, and friends, and they expect significant support from their children.

* Mexicans see it as a time for continued work and hard-earned financial stability.

* In China, younger generations view retirement as an opportunity for a new life but continued careers, while older generations want to stop working and relax. All Chinese people view family as an important source of happiness and support.

* Respondents from Hong Kong view it as a time for rest, relaxation and the enjoyment of accumulated wealth, which is seen as the cornerstone of well-being.

* Respondents from India view later life as a time to live with and be cared for by their families.

* The Japanese look forward to their later years as a time of good health, family considerations and continued fulfillment from work.

Looking at the Bigger Picture -- Forecasting on an Enterprise-Wide Basis

I've been a consulting actuary for more than 25 years now. As I think back at some of the work that I have done and supervised, I realize how flawed some of it has been -- not the work itself, but the nature of the work that we were asked to do. We've been asked to do work in a vacuum, but independent of other parts of our client, its benefits program in total, or its human resources program in total. So, while we may have done an excellent job, the assignment may not have had the value to our client that it could have had we been engaged "properly."

I'm not saying that this was necessarily anyone's fault. Perhaps we were the retirement consultants and weren't being engaged for any other HR work. Perhaps the individual engaging us didn't have purview beyond the retirement plans. In any event, however, I'm taking a guess that I've had clients who looked at bad-case or worst-case scenarios that I presented to them and combined them with other bad-case or worst case scenarios in doing planning.

To illustrate, let me use a (hopefully) absurd hypothetical. Suppose the worst-case for a company's energy division occurs when temperatures are moderate, but the worst case for their agriculture division is when temperatures are extreme. Conversely, the best case for the energy division is extreme temperatures and the best case for the agriculture division is moderate temperatures. So, in total, the enterprise has hedged its risks well.

However, in our hypothetical, each division is left to its own devices to manage its own risks. So, the energy division spends money to "insure" against moderate temperatures and the agriculture division spends money to  "insure" against extreme temperatures. Each division has spent money to manage risks that were already managed on an enterprise-wide basis. Of course, this never happens in real-life, does it? WRONG! It happens all the time. I've seen it.

It's often difficult for all but the top executives in an organization to evaluate risks and "insurance" needs on an enterprise-wide basis. On the other hand, within the human resources function, for example, isn't the entire department its own sub-enterprise? So, as an example, might it not be a good idea to look at the effect of a 1% decrease in underlying interest rates on the entire HR function rather than just on the pension plan? Perhaps in a lot of those scenarios, as interest rates fall, so does inflation and wage increases. So, while pension plan costs might be increasing, compensation costs might be decreasing. In total, HR may be doing a fine job of managing its costs, but if the pension manager is asked to manage pension costs and the compensation manager separately is asked to manage compensation costs, each could be spending resources managing a risk that within the total HR department is already appropriately managed.

I'll comment more on this in the future, but for the time being, I just wanted to give some food for thought. For mid-level managers, the corollary to this is that the better you can view things on an enterprise-wide basis, the faster you will escape that mid level and get to a high level.

Think about it ...

DOL Proposes Sponsor to Participant Disclosure Regulations

Here's an article http://tinyurl.com/2eubs8w that I wrote on the new regulations that the DOL wrote on ERISA Section 404(a). As I said in the article:

Probably the key takeaway is that sponsors (and their service providers) will have a lot of work to do to bring their plan disclosures into compliance with this new rule. Establishment of websites for non-public funds, developing and formatting participant communications, making sure that necessary information is captured, and the redesign of systems to accomplish all of this, will for many sponsors and service providers involve significant expenditure of management time and expense. The larger issue to consider may be how much of the cost associated with these changes will be passed along to plan sponsors and/or participants by those service providers.

No good checklists currently exist to assist sponsors in ensuring that each requirement is covered. Additionally, in some cases, service providers may not be willing or able to assist plan sponsors in complying with requirements. Perhaps this will be an appropriate time for sponsors to use outside experts who can do this effectively rather than having someone struggle to learn the rules once and rarely, if ever,apply them again.

The compliance burden aside, the information actually provided to participants may or may not be helpful. The DOL has done a lot of work – including focus group testing – to come up with a disclosure scheme that will improve participant choices. Whether, in practice, the new rules have their intended effect only time and experience will tell.

DOL Proposes Rules on Annual Funding Notices

Today, the DOL published rules on the defined benefit plan annual funding notice requirement in the Federal Register. Those with severe cases of insomnia can read the proposal here http://edocket.access.gpo.gov/2010/pdf/2010-28890.pdf

Who Furnishes the Notice? The administrator of an PBGC covered defined benefit plan (single employer, multiple employer or multiemployer).

To Whom do they Furnish the Notice? The PBGC, each plan participant and beneficiary, each labor organization representing any of those participants or beneficiaries, and for multiemployer plans to each sponsoring organization with an obligation to contribute.

Who will find the Notice useful? No one that I can discern. This is another example of Congress adding stuff to an already overburdened statute known as ERISA largely for show. Perhaps the PBGC will find value in this, but I expect that for Notices that are distributed in the workplace on paper that the trash and recycle bins will be particularly filled on the days of distribution. Participants just don't know what this stuff means, and generally, they just don't care.

What goes in the Notice? A lot of stuff like:

• Name of the plan
• Name, address and telephone number of the administrator and the principal administrative officer if different
• Each plan sponsor's name and EIN and the plan number
• Whether the plan's FTAP (funding target attainment percentage) (single-employer plans only) is at least 100% for the plan year and for each of the two preceding plan years, and to the extent that it is not, the actual FTAP for those years.
• Multiemployer plans must do the same thing for funded percentage
• Single employer plans must specify for the current plan year and each of the two preceding plan years
• plan assets separating out and prefunding balance and any carryover balance
• plan liabilities under PPA (at risk measure if the plan is at risk)
• Single employer plans must also specify assets and liabilities as of the last day of the plan year
• Multiemployer plans must similarly specify the assets and liabilities for the current plan year as well as the two immediately preceding plan years and as of the last day of the current plan year
• Certain demographic information, mostly counts by active, retired, term vested, etc
• Statements of the plan's funding policy, investment policy and asset allocation
• Multiemployer plans must disclose whether they were in endangered or critical status
• A disclosure of the nature of and the effect of any material events (e.g., plan amendments or assumption changes) that could materially change the plan's funded status by the end of the year following the plan year
• A summary of the rules governing plan termination (single employer) and reorganization (multiemployer)
• A general explanantion of PBGC guarantees
• If applicable, a notice that a 4010 filing was required
• Any other information that the administrator thinks would be helpful in understanding the rest of the notice

Plans that had more than 100 participants on any day of the plan year must furnish the notice within 120 days after the end of the plan year. Smaller plans have until the extended due date for filing the Form 5500 for the plan.

There are limited exceptions to the filing requirement for particularly well-funded plans or plans without significant unfunded liabilities, as well as certain special cases like commercial passenger airlines and airline caterers.

So, I must ask: are these notices useful? In my opinion, they are not. Do they create significant burden for plan  administrators? Of course, they do. Is this just another example of how the Pension Protection Act only served as an additional nail in the coffin for private pension plans? Do I really need to answer that question?

Time to Give a Few Thanks

After 25 years in the consulting business, I'd like to take a few minutes as Thanksgiving approaches to thank some colleagues -- past, present, and perhaps future -- for some important things I have gained from my work experiences from them. I'm sure that I am neglecting some who are deserving, but after all this time, I can't remember everything.

Those who know well may be surprised by some of these, but then again, they may not.

And, before I go any further, let me re-iterate that this is for people I have worked with; if I were to include others, I would have to start with my family.

• Thanks to Jim Donofrio, a colleague for many years and a friend, who taught me that it's not always good enough to answer the questions that the client is asking, but to always be sure to answer the questions they should be asking.
• Thanks to Steve Harrold for teaching me that the client is always right, but that any business decisions have to focus on BOTH sides. In other words, they need to be geared toward serving the client and toward promoting and ensuring profitability.
• Thanks to Jim Durfee for teaching me how to think about technical issues and how to communicate them. Jim was a master at his craft and I hope that he is enjoying the rocking chair that he said he was retiring to.
• Thanks to Brian Dunn and Rich Sternhell for instructing me in "Basic Consulting Skills" back in 1988 or 1989. Hardly a work day goes by that I don't use something that I learned in that class.
• Thanks to Tom Terry and to Don Segal for teaching me how important it is to support our wonderful profession.
• Thanks to Steve Gould for teaching me the value of continuing to learn about everything I could that can ever help me in consulting (the same would go for life, but Steve didn't teach me that).

Funny thing is, I would bet that if any of these people were to read this, they'd be surprised to learn what they are being thanked for. And, again, I know there are people that I have left off. Hopefully, the next time that I give professional thanks in writing, I will remember them as well.

A Rant -- My Turn at the Bully Pulpit

I read a lot of publications that come out from consulting firms, particularly their analyses of guidance from government agencies. Some of it is good, but most of it, in my humble opinion, is not. In my opinion, consulting firms should act as consultants ... to their clients, and perhaps to their prospects.

If a reader wants to read a legal document, wouldn't they turn first to a law firm? Methinks that reader would. So, for example, when reviewing, for example, the relatively new IRS regulations on hybrid plans (e.g., cash balance plans), why is the typical supposedly externally focused article have multiple citations to the minutest areas of regulations? Clients don't care where it comes from. If I tell a client that the regulation says that such and such a design is permissible under the regulations and that some other design is not, they may ask me why, but in my experience, they almost never want a regulatory citation. They hire consultants for their expertise, not to be a library card catalog that can tell the client which regulation to read.

I can't say that I adhere to these all the time, especially because I have never thought of them before, but here are my new Golden Rules for articles on benefits and compensation and other HR and Finance related issues:

1. Keep it to 4 pages or less, unless there is no way around it. Frankly, your readers are likely bored before they get to page 3.
2. Don't worry about which section of the regulation something is in, because most (perhaps all) of your readers don't care.
3. Tell your readers how it may affect them.
4. Do not try to impress your readers with words that they have to look up in the dictionary. Trust me, they won't do it. They'll stop reading instead.
5. Write conversationally, whenever possible. That makes it comfortable for people to read. Most of them really don't like to read their analyses in the prose of Chaucer or the iambic pentameter of Shakespeare.

OK, that felt good. More later.

Would Your Deferred Compensation Plans Survive an IRS Audit?

Since 2005, US nonqualified deferred compensation (NQDC) plans have been subject to the horribly onerous and confiscatory Code Section 409A. Employers and participants, could your plan(s) survive an IRS audit?

In short, NQDC plans that are not in compliance are potentially subject to this treatment:

• Inclusion in income
• Additional 20% federal income tax 
• Interest as if the amounts had not been deferred at the Federal Underpayment Rate plus 1%

Bad stuff, huh? Unlike virtually everything else in the Tax Code, to the extent that there is a failure to comply (whether it is the fault of the employer or employee), the employee pays these taxes. 

How do you have a failure to comply (not an exhaustive list)?

• Plan must be in writing.
• Written plan must be compliant with 409A.
• Each participant must make a bona fide initial deferral election
• Generally before deferring, they must specify in writing when and in what form they will take their distribution.
• Changes to the initial deferral election require a 5-year pushback, and must be made at least one year before the scheduled distribution.
• Plan must be operated in compliance with the written document
• Plan must be operated in compliance with 409A

So, do you know if your plan(s) comply? How would you feel if your plans were audited by the IRS? As part of a current initiative, the IRS is auditing a large number of NQDC plans. The good news is that if you have errors, but you catch them and correct them before the IRS catches them, you may be able to reduce or in some cases totally avoid these 409A penalties. And, for the requirement to have a written plan that is 409A compliant, generally you have until the end of 2010 to fix documentary errors. 

Guidance on the correction programs can be found in Notice 2010-6 to correct documentary failures and Notice 2008-113 to correct operational errors .

These notices are long and complex. Many organizations have found that they don't have the expertise to follow this process in-house. Do you need help?

Nothing in this post is to be construed as legal, tax, or accounting advice. These can only be obtained from qualified counsel.

Ultra-High Earners, How Much Can You Really Defer?

A lot of what we might describe as ultra-high earners (say $500,000 US per year or more) would love to have more tax-favored savings. Physicians, attorneys, and others who are owners of their businesses struggle with this.

In a fairly common design scenario, here is what they can defer into a qualified retirement plan (tax-favored, secure from creditors):

• $16,500 ($22,000 if they reach age 50 or older during the year) to a 401(k) plan
• $22,050 in a profit sharing plan. This is 9% of $245,000 (pay cap). We use 9% because by contributing 3% of pay on behalf of nonhighly compensated employees (NHCEs), the owners are usually able to contribute 9% (3 times 3) to their own accounts
• Perhaps a matching contribution (not more than about $11,000) in the 401(k) plan, but only if they make similar percentage of deferral matches for NHCEs, and the NHCEs participate in the plan to a great enough extent.

Suppose someone told you that by putting aside a little bit more for your NHCEs (generally tax deductible, but you should seek appropriate legal or tax counsel before proceeding), you could quintuple your own deferrals if you are at least age 62 (the numbers are smaller for younger ages, but can triple as early as your 40s). Go through the math, or trust me. Because of the tax deductibility of all these contributions (if you can afford to make them), your income plus deferrals less taxes will often increase ... and you get the benefit of tax-deferred buildup, secure from creditors.

The mechanics aren't that simple, but that's why there are experts. From your standpoint, you just need the willingness to do this, good advisors, and proper counsel.

Does 401(k) Match Not Promote Savings?

A study conducted by James J. Choi (Yale), David Laibson (Harvard), and Brigitte C. Madrian (Harvard) suggests that employer matching contributions to 401(k) plans are not a significant motivator in increasing participation. While we don't have all of the details of the study, we do know that the researchers focused on participants at least age 59 1/2; that is, they focused on participants who, assuming their plans allowed it could make a deferral, get their match and withdraw the amount immediately, creating a taxable event, but not an excise taxable event.

I wish I had access to the actual questions and data. The arbitrage technique that the researchers note is probably not well known. I have not done the research myself, but I would hazard a guess that more benefits professionals than not would neither know of this technique, nor would think to avail themselves of it if they could.

Other factors that could easily be contributing to the data depend upon the sample population. Additional data that might be helpful in understanding this analysis and drawing a conclusion include (but are not limited to) these:

• Did the researchers eliminate people from their study who had recently taken a hardship withdrawal?
• Were any or all funds eligible for immediate in-service withdrawal in all of the plans?
• If not, would factors such as children in college, parents in long-term care, or uncertainty with regard to plan investments have been deterrents?
• Were plan communications to participants clear enough that participants would know AND UNDERSTAND that the technique the researchers describe was available?
• The researchers appear to suggest that even with education, participants would not change their behaviors. Is there reason to believe that participants have become an untrusting group, especially when it comes to employer-provided benefits?

The researchers have drawn surprising conclusions, and while their data may support it, my personal experience in consulting suggests that their conclusions either are flawed or not clearly enough reported in the following article : http://fiduciarynews.com/2010/11/new-study-explains-why-the-401k-match-fails/

In any event, it's interesting food for thought.

Talent Management

Here's a great article on the 7 Tall Tales of Talent Management written by a former colleague, and more importantly, a friend.

http://www.aon.com/attachments/seven_tall_tales.pdf

For Employers, What is a Risky Retirement Plan?

Since the late 80s, the private sector in the US has seen a gradual migration away from defined benefit pension plans (including, but to a lesser extent, hybrid plans such as cash balance plans). The most popular plan now is the 401(k) plan -- virtually every employer with more than 25 employees seems to have one and most provide an employer matching contribution.

In these times where corporate cash flow is king for many, isn't this a risky design? Matching contributions are not limitless, but most companies encourage their employees to increase their participation in the 401(k) plan, and with that increased participation comes an increase in company cost.

Some of the largest companies perform sophisticated forecasting of their 401(k) costs, but most don't. And, even those who do could be off by a material amount.

Further, 401(k) plans do not promote employee retention (unless they are extremely generous) beyond the vesting period (usually 3 years or less). In fact, in the current economy, where many employees are cash-strapped, a meaningful number have left their jobs for the primary purpose of taking a distribution from their 401(k) plan despite the adverse tax consequences. Isn't excessive turnover a significant business risk?

Where can employers turn? With the latest round of cash balance regulations, this may be the much less risky answer. Plan sponsors can now offer a rate of return equal to the rate of return on the trust's investments (or a  fraction thereof) with a lifetime floor. So, to the extent that a plan invests in a well-diversified relatively low-volatility portfolio and properly hedges against interest rate deviations, required cash flow may be more predictable than in a 401(k) plan. And, as long as you are willing to cover your low-paid, there are no refunds that must be given to your high-paid.

No, cash balance plans are not nirvana, but with the recently proposed regulations, they may now be the closest thing in a qualified retirement plan that the US private sector has to offer.

Beware! Is Your Nonqualified Deferred Compensation Plan Linked to a Qualified Plan

The regulations under Code Section 409A have some strange rules related to "linking" nonqualified and qualified retirement plans, or linking multiple nonqualified retirement plans together. Once upon a time, a fairly typical retirement benefit structure include these plans for executives:

• A qualified defined benefit plan
• An "excess plan" with the same formula as the qualified plan, but designed to provide for benefits above the 415 limit and on pay above the pay cap
• A SERP with a different, usually more generous formula, offset by benefits under the other 2 plans

Often, the SERP had different early retirement benefits and different or more subsidized optional forms of benefit available.

This structure can be particularly problematic under 409A (you can read about it in my article here: http://www.aon.com/attachments/jpm_409a.pdf ).

If you have such a structure, the IRS and Treasury is saying that you cannot fix the problem under the documentary correction programs in Notice 2010-6. Currently, the regulatory position is that linked nonqualified plans can be fixed, but nonqualified plans impermissibly linked to qualified plans cannot be fixed penalty free.

Any advice I would give would vary from situation to situation, but if you do have problematic plans, you will want to fix them sooner rather than later.

This blog does not provider legal, tax, or accounting advice which can only come from a qualified provider.

Our Private Retirement System is Broken

In my last post, http://johnhlowell.blogspot.com/2010/11/europeans-want-pensions-do-us-workers.html , I noted that roughly half of European workers in a survey would be willing to give up some of their pay for bigger pension benefits. Likewise, more than one-fourth would trade some pay for better health and disability benefits.

What does all this say? To me, it says that they are, perhaps subconsciously, looking for ways to manage personal risk. As life expectancies rise and retirement savings wane, American workers fear they will not be able to support themselves in their retirement years. The current retirement system is broken.

• Fewer and fewer companies sponsor defined benefit pensions, although most public sector workers still have them. Said differently, the taxes paid by corporate workers pay for the pensions of the public sector, but the private sector workers don't get their own pensions.
• 401(k) plans are not the answer. Yes, they are permanent and portable, but there are issues.
• Companies recently have shown the propensity to decrease their matching contributions with no warning.
• Plan investments have performed poorly over the past decade or so.
• Layoffs are numerous causing discontinuity in savings and forcing many unemployed workers to dip into or even eliminate their savings.
• Pay increases have not kept up with increases in employees' costs of living in recent years.

On that last bullet, did I really say that? Isn't this the country where retirees have not gotten their "automatic COLA increase" for two years running because of no increase in inflation?

Workers have other costs. How much have your contributions to your "employer-provided" health care plan increased over the same two years? How about contributions to other employee benefit plans? I'd bet that the actual benefits that you are eligible for under those plans have decreased over the same period. The cost of education, especially higher education, continues to skyrocket. So, while the Consumer Price Index (CPI) may not have changed much in the last two years, YOUR cost of living probably has.

In 1974, Congress passed a bill known as ERISA -- the Employee Retirement Income Security Act. President Ford signed it into law that year on Labor Day. Note those boldfaced words -- retirement income security. 36 years later, where are we? The private pension system has been gutted. Employer-provided profit sharing is rarely seen. Money purchase plans have largely gone the way of the dinosaur. Americans are expected to save for their own retirement, but are ill-equipped to know either how or how much. 

Unlike the poorly named Pension Protection Act of 2006 (which probably didn't protect anyone's pension outside of PBGC insurance), Small Business Jobs Protection Act which surely didn't protect any jobs, the American Jobs Creation Act of 2004 which does not appear to have created any jobs, and the American Recovery and Reinvestment Act of 2009 which seems to be failing in both of those endeavors, we need a whole new approach. Don't offer me any more band-aids. They don't seem to stick.

Whether it be through tax incentives or by dis-entangling the private sector retirement program from the Tax Code, Americans need incentives to save, mechanisms to save, the ability to save and the motivation to save.

There are lots of experts out there. Unfortunately, there don't appear to be any of them among the 535 elected officials whom taken together, we call Congress.

It's much like Congress trying to figure out how to create jobs. Too many of those in Congress have never actually created a job, just like too many of them have never had to think about a pension.

Wow, ranting does the heart good. What do you think?

Europeans Want Pensions -- Do US Workers as Well?

In a survey of more than 7500 workers across 10 of the leading economies in Europe, Aon Hewitt found that 49% of workers would give up some of their pay for a more generous pension, 35% would take greater health or disability insurance in lieu of some pay, and 26% would give up some pay to be able to deposit it in to a savings plan for some future expense such as a home.

Do American workers think the same way?

With all of the press garnered by generous public and Congressional pensions, this writer believes that most workers yearn for far more retirement security than they currently have, even if it means that they need to give up some level of current compensation. In my next post, I'll touch briefly on some of the issues that I think are at the root of this issue.

Exec Comp Design in 2010 and Beyond

Executive compensation design in 2010 and beyond is not what it used to be. Sarbanes-Oxley and its stepsister, Dodd-Frank, are changing all the rules, all the standard practices, and the public's view of what's right. Here are 10 of the worst practices we see in executive compensation design and some comments on fixing them:

1. Single trigger and gross-up on golden parachutes - For the uninformed, a golden parachute, loosely described is a special package given to an executive in the event of a change-in-control. Golden parachutes are covered in Section 280G of the Internal Revenue Code. Excise taxes on excess parachute payments are covered in Section 4999 of the Code. A single trigger is an arrangement whereby a golden parachute pays out upon change-in-control, regardless of loss of employment for the covered executive. A gross-up occurs where the company pays all the taxes on an executive's parachute payments, and these can be massive. A payout of 2.99 times pay for an executive in the event of a change-in-control and loss of employment is very sufficient.
2. Perquisites - Perquisites, also known as perks or perqs are not inherently evil, but they have gotten way out of hand. In giving perquisites to executives, ensure that they have a business purpose. So, while use of the company airplane by the CEO may have good business reason, a chauffeur for the CEO's spouse probably does not. Special health care benefits (especially executive physicals) for the top executives may be important to the risk management processes of the organization, but multiple company-paid country club memberships likely are not.
3. Exchange of Underwater Stock Options - Suppose you granted a whole bunch of stock options to your executives in 2007 and now the company stock is selling for much less than the strike price of the options, then those options are said to be underwater. In recent years, a number of companies have been exchanging such options for ones that may be more likely to have value to those executives. Gee, do the shareholders who bought the stock in 2007 get to similarly exchange their shares? They had nothing to do with the stock price declining, don't they deserve a deal at least as good as what the executives?
4. Excessive Share Dilution - Authorizing too many shares for executive compensation programs may dilute shareholder value. While we would say never say never, doing this too often is a sign that your company is putting its executives ahead of its shareholders.
5. Evergreen Employment Contracts - I've never had a rolling, self-renewing employment contract, have you? You're not sure. Perhaps the best examples of such contracts are found in college athletics. Hometown U hires Coach Goodplayer and gives him a 5-year contract to coach the football team at a salary of $2 million per year (plus perquisites of course). At the end of each year, Coach G's contract automatically resets to be a new 5-year deal, unless Hometown U decides to cut off the evergreen part. Finally, in 2013, when Coach G has a bad season and the alumni say to get rid of him, Hometown U owes him 4 years of salary and perquisites just to make him go away.
6. Severance for Failure - The real live cases are well known. Living in the Atlanta area, the best known case here was Bob Nardelli's deal at The Home Depot. Under Mr. Nardelli's leadership, HD stock price fell precipitously. After 6 years at the helm, he resigned under pressure with a severance package valued at roughly $210 million according to http://money.cnn.com/2007/01/03/news/companies/home_depot/index.htm
7. Disconnects in Incentive Payouts and Timing - Incentive payouts should make sense. Executives should be expected to perform at high levels. Paying out a bonus for poor performance, for example, should be viewed as taboo. Consider a circuit breaker whereby the switch flips to off if an executive hits less than 80% of his or her target. Does that seem to harsh? If an executive is not hitting 80% of target, think about what is happening to the poor shareholder.
8. Discretionary Incentive Designs - In days of yore, most discretion on incentive payouts was reserved for the CEO, and not the CEO's bonus. That is, the CEO had the discretion to unilaterally increase (yes a discretionary decrease was available, but rarely if ever happened in practice) the bonus of any of his or her direct reports beyond what the incentive plan design would have recommended as a bonus. In the new world of executive compensation, such discretion lies only with the Board, and the Board's discretion exists to ratchet incentive payouts downward.
9. Poor Goal-Setting that Motivates Imprudent Risk-Taking - Be very careful how you design a set of goals or an incentive plan. Poor design might motivate behaviors that are against the goals of the organization. Think about the crisis in the financial services sector. Think Bear Stearns, Countrywide Mortgage, AIG, and others. News reports certainly suggested that executives at each of these organizations were being well-rewarded for taking incredible risks -- risks that eventually led to corporate downfall. Take steps to ensure that taking risks beyond those that the company (and its shareholders) would consider acceptable be de-motivated.
10. Design Based on a Mis-Chosen Peer Group - The peer groups for many companies have historically been chosen by the executives at those companies. How did they choose them? Many chose them very reasonably, but some cherry-picked that peer group. In other words, they picked companies that looked somewhat like theirs, but that they knew were underperforming. The peer group should consist of high performing companies of similar size and divisional peer groups should be based on companies and their segments of similar size. Companies that are known to be underperforming should be left out.

So, there you have it ... my Top 10.

Nothing in this post or this blog should be construed to represent legal, accounting or tax advice, and while this is thought to be generally correct, nothing herein represents consulting advice for any specific organization.

401(k) Recordkeeper

Who is your 401(k) recordkeeper? Are they best in class? Each year, Plan Sponsor magazine surveys plan sponsors to get their feedback. See the results of their survey here: http://www.plansponsor.com/2010_DC_Survey.aspx

401(k) Fee Disclosures

The DOL has undertaken a 3-part project on 401(k) fee disclosures with focus on:

• Provider fees disclosed on Form 5500 Schedule C
• Provider-to-Sponsor fee disclosure
• Sponsor-to-Participant Fee Disclosure

I was featured in an Employee Benefit News podcast this month on the topic: "5 Minutes With".

Listen here if you dare: http://ebn.benefitnews.com/pdfs/FMW1110_KK.JohnLowell.mp3 

Do You Know if You are a Retirement Plan Fiduciary?

Everyone who works with a retirement plan should act in a fiduciary manner, but many have claimed over time that they are not fiduciaries. Why? They don't want the obligations, they don't want the responsibilities, they don't want the liability.

Until recently, it was fairly easy for outsiders (3rd party providers) to stay outside of the definition of fiduciary under ERISA, but DOL proposed regulations issued on October 21 will pull many under the umbrella of the fiduciary label.

Are you one of the "new fiduciaries" who didn't know you were? http://www.aon.com/attachments/fiduciary_redef_nov2010.pdf

Debt Commission, Retirement Plans and Retirement Policy

This February, President Obama created National Commission on Fiscal Responsibility and Reform, sometimes referred to in the press as the Debt Commission or Debt Panel. The Commission has made the headlines recently with its draft recommendations ( http://big.assets.huffingtonpost.com/CoChairDraft.pdf ).

What does this mean for your retirement? In this article, we looked at how it might affect both Social Security and qualified (pension, 401(k), etc.) retirement plans. How will it affect your retirement?

Learn more here: http://www.aon.com/attachments/debt_comm_oct2010.pdf

In Plan Roth Conversions

Did you know that you now have an opportunity to convert your traditional 401(k) account to a Roth account. This means that you can pay taxes now (at current rates), and assuming that the Internal Revenue Code does not change, pay no future taxes on both those amounts and their future in-plan investment earnings. In a potentially rising tax rate environment, this will be a good idea for some (each person's situation is different and before making such a decision, you should consult your personal financial and tax advisors). As is frequently the case, the rules are not as simple as we might like.

Learn more here: http://www.aon.com/attachments/roth_conversions_oct2010.pdf

Converting your DB SERP to a DC SERP (Part 2)

In Part 2 of this series, originally published in September, we look at the 409A implications of converting a DB SERP to a DC SERP.

View the article here: http://www.aon.com/attachments/dbdcserp_409A_sep2010.pdf

Converting your DB SERP to a DC SERP

Here is an article (first in a series) that I co-wrote back in August this year on nonqualified plans. As many companies freeze and terminate their qualified defined benefit plans, they similarly change their nonqualified offerings from DC to DB.

You can find the article here: http://www.aon.com/attachments/dbdc_serp_aug2010.pdf

Welcome to My Blog

Thank you for checking out my blog. I'm an experienced consulting actuary of 25+ years with significant experience with defined benefit and defined contribution plans, and executive benefits and compensation. I've looked at things from a human resources perspective, a finance perspective, and a risk management perspective among others.

I am an Associate of the Society of Actuaries, an Enrolled Actuary, a Member of the American Academy of Actuaries and a Fellow of the Conference of Consulting Actuaries, as well as currently serving on the Board of Directors of the Conference.

I've written literally hundreds of articles on topics ranging from the Pension Protection Act of 2006 to Health Care Reform, and from 409A to fiduciary and plan governance issues in DC plans. I've been featured in podcasts (most recently in the November issue of EBN) http://ebn.benefitnews.com/pdfs/FMW1110_KK.JohnLowell.mp3 .

If you have a topic that you would like to see covered, let me know. In the meantime, please enjoy.