Wednesday, January 27, 2016

Preparing the Higher Paid for Retirement

Retirement readiness is getting lots of press these days. With the decrease in the number of ongoing defined benefit (DB) retirement plan, many people are finding that they are not on a path to perhaps ever be ready to retire. While most of the focus has been on lower paid, nonhighly compensated (NHCE) workers, the discussion may be more relevant for the higher paid (HCEs) workers, especially those who are not among the very highest paid. When I was growing up, these people were often referred to as the upper middle class. Today, I don't hear that term as often.

Yesterday, I read an article that on its surface would seem to address this issue. It focused on the small employer, small plan world. It laid out a multi-step additive solution:

  • Safe harbor 401(k)
  • Cross-tested profit sharing
  • Cash balance plan
  • Nonqualified plan
There is nothing wrong with this solution. In fact, at companies that take this approach, it is likely that full career employees whether they are NHCEs or HCEs will have sufficient retirement benefits to be able to retire with a style of living similar to what they had when they were working. 

That's not bad.

But, as I said, the focus here is on small employers in which the management team (often one or two owners) are earning really substantial amounts of money. While the approach outlined above and in the article may be somewhat optimal, it's not unlikely that with a less optimal approach that these HCEs could retire comfortably.

Before we go on, however, why should we care about the rest of the HCEs -- those people who for the most part have annual incomes in the range of, say, $125,000 to $200,000. They are pretty well paid. What could possibly make it difficult for them?

They do pay more in taxes. It's not unlikely that they will have to fund college educations for their child(ren) as they may make a little too much for significant financial aid to be available. And, as most people aspire to a style of living in retirement at least similar to what they had when they were working, it's going to take a lot more savings for these people to make it to that retirement target. Further, in today's world, with so many employees having a 401(k) plan as their only retirement vehicle, those HCEs who would like to save as much as the financial gurus recommend are just not able to do that in a qualified plan.

Many of these same HCEs have jobs that are not physically stressful. As a result, if they choose to, and if an employer will have them, these people can work well past traditional retirement ages. One might question whether that is good for society. Is it a desirable result? (I'll leave the thinking on that to the reader.)

What can we do? 

Since most people reading this (likely all) will not be legislators, we can't change the law even if that might be a desirable result. As I have said many times, using the 401(k) as a core retirement plan prepares almost no one for retirement. To the extent that companies feel any obligation to their employees, they must do something different.

That different plan should have some particular characteristics:

  • It should be affordable to the employer
  • The cost of that plan should be relatively stable; that is, volatility should be limited
  • The plan should offer annuity and lump sum options to participants when they reach retirement age
  • The plan should be easy to understand
  • The plan should be easy to administer
  • The benefit should be portable since in today's modern workforce, an employee who stays with you for more than five years is the exception, not the norm
  • It should benefit the rank and file well
  • It should benefit the upper middle class well
  • It should benefit the executive group well
Most of the retirement world doesn't seem to want you to know about it, but this plan exists today and it is specifically sanctioned by the Internal Revenue Code.

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