If It Wasn't Broke, Why Did You Try to Fix It?

I just returned from the Conference of Consulting Actuaries Annual Meeting (well, I haven't quite returned and I took some personal time in between). As usual, the meeting had some outstanding sessions with great learning opportunities. But, there is one theme that bothers me, and this is not a reflection on the meeting, but on the consulting profession -- too often, when something is working just fine, we have to try to fix it.

More on that in a minute, but first, for my regular readers (and I know that I am bold in putting an s at the end of reader), I apologize for the hiatus. The Annual Meeting was a busy place and time ... and then there was vacation, and while my mind was filled with lots of thoughts, this blog was not one of them.

Returning to my theme, however, I learned about some new (or maybe really old) designs for defined benefit plans. They were intended to be THE SOLUTION. We saw some illustrations. They produced very slightly different results than plans that were already popular. The new ones will be difficult to administer, and, even compared to DB plans of days past, these are designs that no participants will understand.

What's the point?

I also heard about companies that were doing more aggressive cost-sharing in their health care plans. What a wonderful euphemism -- cost-sharing. Isn't that just another name for, you as the employee are going to pay a lot more while we as the employer try to hold our costs down. 

Here is the situation where I find this to be the most laughable. Consider a company that touts its wellness programs. And, it wants to make sure that its employees are healthy and stay healthy (at least that's the propaganda). So, they offer you one regular checkup per year. And, they pay for it ... all of it. But, here's the catch. Suppose you need maintenance medication. Perhaps you have nothing but healthy lifestyle habits. But, your family has a history of high cholesterol. You are burdened with it, too. The longest prescription you can get is 180 days. To get your next refill, you have to go back and see your doctor for blood work (so, that's labs and an office visit). And, in your effort to stay well, neither of them is covered. 

This is the new design that is being touted. 

I liked the old system better. It wasn't broken. Now, it's fixed, and the new system IS broken.

"I see," said the blind man.

Pension Limits for 2012

The IRS has announced retirement plan limits for 2012. You can see them at the IRS website or see the text below:

• The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000.
• The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
• The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $58,000 and $68,000, up from $56,000 and $66,000 in 2011.  For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $92,000 to $112,000, up from $90,000 to $110,000.  For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $173,000 and $183,000, up from $169,000 and $179,000.
• The AGI phase-out range for taxpayers making contributions to a Roth IRA is $173,000 to $183,000 for married couples filing jointly, up from $169,000 to $179,000 in 2011.  For singles and heads of household, the income phase-out range is $110,000 to $125,000, up from $107,000 to $122,000.  For a married individual filing a separate return who is covered by a retirement plan at work, the phase-out range remains $0 to $10,000.
• The AGI limit for the saver’s credit (also known as the retirement savings contributions credit) for low-and moderate-income workers is $57,500 for married couples filing jointly, up from $56,500 in 2011; $43,125 for heads of household, up from $42,375; and $28,750 for married individuals filing separately and for singles, up from $28,250.

Below are details on both the unchanged and adjusted limitations.

Section 415 of the Internal Revenue Code provides for dollar limitations on benefits and contributions under qualified retirement plans.  Section 415(d) requires that the Commissioner annually adjust these limits for cost of living increases.  Other limitations applicable to deferred compensation plans are also affected by these adjustments under Section 415.  Under Section 415(d), the adjustments are to be made pursuant to adjustment procedures which are similar to those used to adjust benefit amounts under Section 215(i)(2)(A) of the Social Security Act.

The limitations that are adjusted by reference to Section 415(d) generally will change for 2012 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment.  For example, the limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) will increase from $16,500 to $17,000 for 2012.  This limitation affects elective deferrals to Section 401(k) plans, Section 403(b) plans, and the Federal Government’s Thrift Savings Plan.

Effective January 1, 2012, the limitation on the annual benefit under a defined benefit plan under section 415(b)(1)(A) is increased from $195,000 to $200,000.

Under section 1.415(d)-1(a)(2)(ii) of the Income Tax Regulations, the adjustment to the limitation under a defined benefit plan under section 415(b)(1)(B) is determined using a special rule.  This special rule takes into account the following recent history of changes in the cost-of-living indexes:  (1) the cost-of-living index for the quarter ended September 30, 2009, was less than the cost-of-living index for the quarter ended September 30, 2008; (2) the cost-of-living index for the quarter ended September 30, 2010, was greater than the cost-of-living index for the quarter ended September 30, 2009, but less than the cost-of-living index for the quarter ended September 30, 2008; and (3) the cost-of-living index for the quarter ended September 30, 2011, was greater than the cost-of-living indexes for all prior periods.

For a participant who separated from service before January 1, 2010, the limitation under a defined benefit plan under Section 415(b)(1)(B) for 2012 is computed by multiplying the participant's 2011 compensation limitation by 1.0327 in order to reflect changes in the cost-of-living index from the quarter ended September 30, 2008, to the quarter ended September 30, 2011.  For a participant who separated from service during 2010 or 2011, the limitation under a defined benefit plan under Section 415(b)(1)(B) for 2012 is computed by multiplying the participant's 2011 compensation limitation by 1.0376 in order to reflect changes in the cost-of-living index from the quarter ended September 30, 2010, to the quarter ended September 30, 2011.

The limitation for defined contribution plans under Section 415(c)(1)(A) is increased in 2012 from $49,000 to $50,000.

The Code provides that various other dollar amounts are to be adjusted at the same time and in the same manner as the dollar limitation of Section 415(b)(1)(A).  After taking into account the applicable rounding rules, the amounts for 2012 are as follows:

The limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) is increased from $16,500 to $17,000.

The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $245,000 to $250,000.

The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $160,000 to $165,000.

The dollar amount under Section 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5 year distribution period is increased from $985,000 to $1,015,000, while the dollar amount used to determine the lengthening of the 5 year distribution period is increased from $195,000 to $200,000.

The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $110,000 to $115,000.

The dollar limitation under Section 414(v)(2)(B)(i) for catch-up contributions to an applicable employer plan other than a plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $5,500.  The dollar limitation under Section 414(v)(2)(B)(ii) for catch-up contributions to an applicable employer plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $2,500.

The annual compensation limitation under Section 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost of living adjustments to the compensation limitation under the plan under Section 401(a)(17) to be taken into account, is increased from $360,000 to $375,000.

The compensation amount under Section 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $550.

The limitation under Section 408(p)(2)(E) regarding SIMPLE retirement accounts remains unchanged at $11,500.

The limitation on deferrals under Section 457(e)(15) concerning deferred compensation plans of state and local governments and tax-exempt organizations is increased from $16,500 to $17,000.

The compensation amounts under Section 1.61 21(f)(5)(i) of the Income Tax Regulations concerning the definition of “control employee” for fringe benefit valuation purposes is increased from $95,000 to $100,000.  The compensation amount under Section 1.61 21(f)(5)(iii) is increased from $195,000 to $205,000.

The Code also provides that several pension-related amounts are to be adjusted using the cost-of-living adjustment under Section 1(f)(3).  After taking the applicable rounding rules into account, the amounts for 2012 are as follows:

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for married taxpayers filing a joint return is increased from $34,000 to $34,500; the limitation under Section 25B(b)(1)(B) is increased from $36,500 to $37,500; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $56,500 to $57,500.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $25,500 to $25,875; the limitation under Section 25B(b)(1)(B) is increased from $27,375 to $28,125; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $42,375 to $43,125.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $17,000 to $17,250; the limitation under Section 25B(b)(1)(B) is increased from $18,250 to $18,750; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $28,250 to $28,750.

The deductible amount under § 219(b)(5)(A) for an individual making qualified retirement contributions remains unchanged at $5,000.

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is increased from $90,000 to $92,000.  The applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $56,000 to $58,000.  The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $169,000 to $173,000.

The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(I) for determining the maximum Roth IRA contribution for married taxpayers filing a joint return or for taxpayers filing as a qualifying widow(er) is increased from $169,000 to $173,000.  The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $107,000 to $110,000.

The dollar amount under Section 430(c)(7)(D)(i)(II) used to determine excess employee compensation with respect to a single-employer defined benefit pension plan for which the special election under section 430(c)(2)(D) has been made is increased from $1,014,000 to $1,039,000.

More on CEO Pay -- Whose Fault Is It?

OK, I'll say it -- US Chief Executive Officers, as a group, get paid a lot of money. There! Are they worth what they get paid? Some are, some are not. Gee, you're not surprised yet by anything I've said?

My question to you or to anyone else is how did this happen. I heard somewhere this week that back in the 80s, US CEOs had pay roughly equal to 30 times the median pay for US workers. The same person said that multiple is now in the 300s or 400s. Assuming that you think that is too much on average (and I do think it is), is it my fault that it got that way? Is it yours?

Times have changed. Compensation packages have changed. Some executive compensation consultancies found for a while that the best way to get hired was to be able to show that they could get the executives the most money. There was no independence of compensation committees back then, at least it wasn't particularly required.

Again, back in the 80s, how were CEOs paid? For most, they got a base pay and they got a bonus. Some received equity awards or grants, but that was nowhere near as common.

Three things happened:

1. Companies started giving mega-grants.
2. The country at large and the politicians decided CEO and other executive compensation was too high.
3. Congress was smart enough or not to put Section 162(m) (the million pay cap for deductibility) into the Code.

My memory isn't perfect on this one, but this is my blog, so I can write as if it is. The first mega-grant that I remember was paid by The Coca-Cola Company. Mr. Goizueta became the CEO of Coca-Cola in 1980 at the age of 48 and he was a superstar. The Board thought so, the Compensation Committee thought so, shareholders thought so, Wall Street thought so, and competitors thought so. Coca-Cola wanted to lock Mr. Goizueta in and to do so, they gave him an award of 1,000,000 restricted shares. What this meant, roughly speaking, was that if he stuck around for 10 years, he would get one million shares of KO stock which traded around $83 per share at the time. 

That was a lot of money. Wall Street thought that Coca-Cola had made a great decision.  

So, other companies followed suit. Executive compensation consultancies and practices within larger consulting firms actively trained their people on the intricacies of mega-grants. 

Two things happened. The economy plummeted as it does from time to time, and as often happens when the economy plummets, people think that executives make too much money (oftentimes they do). So, Congress "solved" the problem. 

The Fools on the Hill (Capitol Hill) added Section 162(m) to the Code saying that pay for the top five executives in excess of $1 million in a year was generally not deductible on the corporate tax return. But, they put in an exception for certain performance based pay. 

Ah, a loophole! Who woulda thunk it?

In the Internal Revenue Code, where there's a loophole, there's a loop to put through it, and virtually everyone could find this loop. So, CEOs of large companies everywhere suddenly had base pay at or below $1 million and complex performance clauses that could pay them lots of money, especially when the stock market was heading up. 

Finally, the SEC entered the picture. As they refined and further refined the proxy rules for registrant companies, the SEC decided how pay should be defined. So, now, where CEO compensation can decrease significantly if interest rates are high and the stock market is low on the last day of the company's fiscal year, or conversely, compensation can increase because interest rates plummet on December 31 while the stock market hits new highs, different groups have the opportunity to cherry-pick their data.

In any event, according to the data I heard this week, CEO pay is now a multiple of 400 or so of the median worker pay. I don't know where the number came from. I'm not sure that I care because I know that the number is a contrived one. On the other hand, that multiple is too high by anyone's standards.

It's not my fault, though. Is it yours?

On the Origin of Species - Retirement Plan Style

It's been about 150 years since Charles Darwin wrote about his theory of evolution. He also, as we know, discussed Spencer's phrase "survival of the fittest." This seems to work pretty well in the worlds of zoology, botany, and ecology. But, does it work with regard to retirement plans?

I guess that part of the premise would need to include what exactly is a fit retirement plan. Is it a plan that allows people to retire? The terminology alone would seem to suggest that. Is it a plan which might assist people in their goal of retiring, but doesn't cost an employer very much? Is it a plan, jury rigged over the years, to assist politicians in their never ending goal of changing stuff to help them get re-elected?

I'd like to believe that a fit retirement plan or retirement system will allow participants to retire after a normal working lifetime. 30 years ago, we had such a system, and it existed without 401(k) plans. But, I guess I must be mistaken, as clearly, that system has not survived. But, it's not been without outside influence -- largely Congress. You see, every year or two for the last 30, when it's come time to develop a budget for the upcoming fiscal year and the country has needed some revenue enhancers, Congress looks to the retirement system. And, it's a really cool solution, too, because nobody understands what Congress is doing (and that includes Congress), but it doesn't affect Congressional retirement benefits.

In his Origin of the Species, Mr. Darwin did not have to consider Congress, or even Parliament.

The 401(k) system cannot be the correct answer. It has too many rules. And, many of the rules and goals conflict with each other. Consider a system containing all of these features.

• If your low-paid don't participate to a great enough extent, your high-paid aren't allowed to.
• If you don't communicate the plan and its benefits to the low-paid, they won't participate to a great extent.
• If you do communicate the plan and its benefits to the low-paid, then the plan is useful to the high-paid, but it costs the company more, cutting into profits.
• Cutting into profits competes with the goals of the management team.
• This affects dividends paid to shareholders which, in theory, is the reason a person holds shares in a company.

And, this is now the primary retirement vehicle for the majority of US companies.

But, wait, we have a Presidential election coming up in just over a year. And, with that, 33 or 34 Senate seats are up for grabs as well as 435 seats (actually a bunch of them are not contested) in the House of Representatives. With those elections will come a bunch of new allegiances. Will your Congressman or Congresswomen be aligned to the Occupy movement, the Tea Party, the Green, the Libertarians or some other group? How about the others? I'm not smart enough to tell you. But, I am smart enough to know that the allegiances of the new group will be different than those of the existing group. So, with this new group will come retirement plan change. 

Maybe this change will be 401(k) biased. Maybe it will revolutionize retirement plans. But in any event, it will do something.

And, you heard it here first, my bet is that they will do something stupid.

If we look at the way things are now, though, people in the workforce are just not going to be able to retire. Yes, some will, but most won't. Certainly, they won't be able to by age 65. What's so special about age 65? It's been a retirement age for a long time. When it first came about, those who were fortunate enough to outlive that age usually didn't do it by too much. Now they do. So many argue that the working lifetime should be extended. But companies don't want to keep the post-65ers employed. These days, they seem to prefer that with the post-55ers as well. And, for that matter, by the time people hit age 65, most of them are just worn out from full-time work.

The 401(k) isn't going to fix it. Maybe we need a fitter plan.

A New Take on Just How Much You Need to Retire

I was part of an interesting conversation last Friday. Since I didn't ask if I could attribute to the specific individual, I'll leave his name out. The general topic in this part of the conversation was how much money do you need to retire.

I know -- you've heard it before. 10 times pay, 15 times pay, some other number times pay. But, last Friday, I heard a different answer. Suppose you look at things based on health factors. You've probably thought about that, but I don't think you have thought about it the way this gentleman has (I am going to deviate from what he said, but am using his basic premise).

Suppose we break the population into 4 quadrants. On the vertical axis, put your estimated health care costs compared to a typical person without regard to life expectancy. On the horizontal axis, put your life expectancy based on your family history and your health. I realize that you can't be exact, but you have a pretty good idea if you expect to outlive the norm or not.

When we look at the center of the chart (average life expectancy, average health care costs), perhaps you will need 16 times final pay to live happily in retirement. Consider the other four quadrants (using map directions):

• Northeast -- long life with high medical expenses requires high multiple
• Southeast -- long life with low medical expenses requires medium multiple
• Northwest -- short life with high medical expenses requires medium multiple
• Southwest -- short life with low medical expenses requires low multiple

It's so simple, yet so elegant. And, I've never seen it put this way before. 

The particular individual cited in this article is doing research. He plans to release a publication with tremendous detail on this topic. Saying much more would steal his thunder, but it was such an interesting yet simple concept that I felt the need to say something. 

Stay tuned.

How Much Should a CEO Be Paid?

That sure sounds like a simple question. It has no difficult words. It's not a compound question. It's the type that if an attorney asked a witness on cross-examination, there would be no objection as to form.

I've noticed the Occupy [Wall Street] movement and one of their major beefs is how much CEOs of US companies are being paid. On Facebook, I have seen a chart suggesting that US CEOs make on average 475 times as much as the median US worker (the data being used suggests that the median worker earns $33,840 per year) which suggests that the average CEO makes somewhere in the neighborhood of $15 to 16 million per year. That's a lot of money, but there are not a whole lot of CEOs that actually make that much. And, when the people who put together that chart did their homework, so to speak, they used compensation from proxy disclosures.

Executive compensation (and related topics) practitioners will know that this is not an apples to apples comparison. While many of the components of CEO pay do not apply to the median worker, note that CEO pay includes the value of retirement plans, for example, while median worker pay does not. Further, in the years where CEO pay, relative to the median worker is highest, this is significantly a function of prevailing interest rates on corporate high grade bonds. I'm not saying that this is the right way or the wrong way to do this, I'm just saying that this is the way it is.

But, we still haven't approached the answer of how much a CEO should be paid. So, I asked a few people who have been objecting quite strenuously to CEO compensation. They don't know either. But, the only answer that I got more than once was "less than 10 times what the average worker makes."

You know what. I know a few corporate CEOs (not real well, but in passing). And, not a single one of them would do their job if their pay was limited to less than 10 times what the average worker makes. A good CEO delivers value to a company. How much value? I don't know. Perhaps we will see as we watch Apple over the next couple of years in the post-Steve Jobs era.

Should a CEO earn more than 'talent'? In my opinion, generally a good CEO should earn more. They have larger responsibilities. While talent can swing earnings significantly for a segment of a business, the CEO sets the direction for the business.

So, I asked one of these people who thought that CEOs should less than 10 times what the average worker makes how much they thought that talent should make. I asked them if Lady Gaga should have made upwards of $50 million in 2010. They answered probably not. PROBABLY not! That means that there is a chance that she should earn that much, but the person who is responsible for having a recording contract shouldn't earn more than about $340,000. How about Peyton Manning. I think his football earnings for 2011 are between $10 and 20 million. Add that to his endorsement earnings and he is pretty well compensated. Is he earning that much in 2011? Does he deserve it? He's had a pretty good career, far better than most, but if he were a CEO in 2011, his compensation would be hit a lot more by his inability to do his job this year.

I know. CEOs don't get career-limiting injuries. But, in any case, it's a tough comparison to make. I don't know how much a good CEO or a bad CEO should make, but neither do the protesters. Perhaps, though, they should get a few facts straight before they present them.

9 9 9 or Nein Nein Nein

If you haven't been under a rock, you have at least heard an inkling about Herman Cain's "9 9 9 Plan." If you like, you can read about it on his website (hermancain.com) or you can get the whole plan hear in just a few bullet points:

• Eliminate the Internal Revenue Code (the Tax Code or the Code)
• Impose a flat 9% personal income tax on all income, apparently excluding bonafide charitable contributions
• Impose a flat business income tax at a rate of 9%, eliminating all deductions (the media and the activists on both sides and in the center usually call these loopholes)
• Impose a 9% sales tax on, as I understand it, the purchase of all new (not pre-owned) end products

Mr. Cain says that it is revenue neutral, or better. I have not had a chance to review either his math or his assumptions, so I can't vouch for him, or dispute his claims.

I have to give credit to Jay Leno for the second part of my blog post title. Mr. Cain was a guest on the Tonight Show the other night and Leno talked about Republican Presidential candidates being fluent in foreign languages: Romney in French, Huntsman in Mandarin and Cain in German as nein, nein, nein translates to no, no, no.

But, back to the point of the post, look at that first bullet. Eliminate the Internal Revenue Code. If you are an average American, or even a not so average American, you probably think that's great. But, there are complications. And, if we are pointing them out here, they probably relate somehow to benefits or compensation.

Do you participate in a 401(k) plan? You do, now there's a shocker. The fact is that the large majority of working Americans either participate in a 401(k) plan, or are at least eligible to. And, why is it called a 401(k) plan? Well, duh, it's sanctioned by Section 401(k) of the Internal Revenue Code. That's why you as a participant have the opportunity to make deferrals on a pre-tax basis and not pay any tax on the money until you take a distribution. And, there are rules in the Code related to those distributions. Those would all go away. When would your distribution be taxed? Well, I don't know. Since the build-up in your account is exempt from taxes under Code Section 501(a) until you take the money, would it no longer be exempt from taxes if there ceased to be a Section 501(a) of the Code? I don't know.

Suppose you made Roth contributions. That means the money was taxed in the year that you contributed it, but would not be taxed upon distribution. So, it's already been taxed, but with no tax exemption, would it be taxed again? I don't know. 

How about life insurance that you may be the beneficiary of? Suppose your parent took out a $1 million policy on their own life and made you the beneficiary. Currently, if that parent were to die, that $1 million would be exempt from income taxation (it would be subject to estate taxation) because the Code exempts it.  What would happen under 9 9 9? I don't know.

And, you were one of those parents who chose to save for your child's college education using a 529 Savings Plan. Why is it called a 529 plan? It's sanctioned under Section 529 of the Internal Revenue Code. Would it lose its tax effectiveness? I don't know.

You would think that Donald Rumsfeld was my role model.

With regard to 9 9 9, you may like it or you may not. But, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know.

I don't know, do you?