Qualified Retirement Plans Are Not a Congressional Toy

I was at the Southern Employee Benefits Conference Annual Educational event yesterday. One of the speakers had just returned from a conference in Washington where there were a number of presenters who are staffers on The (Capitol) Hill. Reports are that staffers from both parties strongly implied that tax-favored status of 401(k) and other qualified retirement plans may be in jeopardy.

In short, this is bad -- really bad.

The eventual ability of many Americans to retire in the recently traditional sense is already in jeopardy. Various surveys that I have seen say that the majority of Americans in the workforce have no savings outside of their qualified retirement plans and for most, those are 401(k) plans only. If Congress were to eliminate some or all of the tax breaks associated with them, I fear that those savings would disappear as well for many people. All but those who had the ability and foresight to save and invest on their own would be left to find sources of income until they reached their deathbeds.

That is bad -- really bad.

I don't think I have ranted too much for a while, but this topic is always good for one.

When Congress looks at issues that have tax effects, they break them into two categories -- tax revenues and tax expenditures. Anything that causes the government to collect less money in taxes is a tax expenditure.

Therein lies the rub. Most things that Congress can do for the country cost money. If Congress chooses to send a bill to the President that provides for some improvement that was not previously planned, it needs to pay for those costs. It often chooses to do so through reductions in tax expenditures.

According to IRS publications, the two largest current tax expenditures are for employer-provided health insurance and for employer-provided retirement plans. Health insurance is a sacred cow. It's not going away unless or until we have a single-payer system. Retirement does not appear to be so sacred.

And, retirement always seems to be a good revenue raiser, at least the way that the Congressional Budget Office (CBO) scores bills. The CBO looks at 10-year costs or revenues. So, Congress needs money to pay for a highway bill -- they reduce required contributions to defined benefit plans. That cuts tax expenditures ... in the short run.

As I have said many times, Congress should not intermingle tax policy and public policy. Ever!

Sadly, Congress does not listen to me. All of my readers know that Congress should listen to me, at least on these issues, but alas, they are not so wise.

So, we are left with a Congress that makes changes to employee benefit plans in the most interesting places. Here are a few that will either refresh your memory or leave you scratching your head or both:

• The Uruguay Round Agreements that led to the formation of the World Trade Organization
• HATFA, the 2014 highway funding bill
• Several defense appropriations acts
• Any number of omnibus budget reconciliation acts (OBRAs)
• KETRA, the Katrina Emergency Tax Relief Act of 2005
• SBJPA, the Small Business Jobs Protection Act

If Congress wants to eliminate the tax breaks for qualified plans, it should do so by eliminating the federal income tax. If Congress chooses not to do that, don't mess with them.

Frightening Data on DC Plan Ownership

According to an article in this morning's News Dash from Plan Sponsor, fewer families had an individual account retirement plan (defined contribution or IRA) in 2013 than in 2010. However, on the bright side, average account balances have increased over the same period.

What do we learn from this? It's difficult to know for sure, but as is my wont on my blog, I'm going to take a shot at working it out.

Why are average account balances up? Well, the equity markets have performed pretty well over the last few years. Combine that with the fact that there has been time for additional contributions to those accounts and this makes sense. When we combine this, however, with my rationale for the prevalence of accounts decreasing, it may look troubling.

That the number of families with individual account retirement plans is decreasing suggests underlying issues with the economy. What I suspect is that many long-term unemployed or under-employed have had to liquidate accounts that they had a few years ago in order to survive. People laid off from jobs have taken distributions rather than rollovers to live on. I suspect that more often than not, these have been total distributions from smaller accounts. By eliminating some of the smaller account balances, the average and median accounts have grown in size.

That only about 50% of families have individual retirement accounts and only about 65% have any retirement plan at all is not good news for our future economy. How will the remaining 35% live? Moreover, among those 65%, will they have enough to survive in retirement?

The way it looks to me is that for people who are able to fully utilize their 401(k) or other retirement program for their entire working lifetimes, retirement may be comfortable. But this data suggests that this will be a substantial minority. For the rest, the retirement system is failing us.

30 years ago, defined benefit (DB) plans were the bulwark of the corporate retirement system. After years of Congressional meddling, many employers consider DB plans to be impractical. At the same time with further emphasis on individual responsibility, the burden of providing a retirement benefit has been shifted largely to employees.

If you are good at Googling or Binging, you can easily find projections from lots of smart people showing that a good 401(k) plan will be sufficient for responsible employees to retire on. In my opinion, most of these projections are deficient. You just don't see projections that consider leakage including:

• Unemployment for a meaningful period of time
• The necessity to take a job for a short or long time that does not have a savings plan
• Increased cost-shifting of all benefits to the employee which may reduce an employee's ability to save
• High-deductible health plans which force employees in many cases to pay significant amounts out-of-pocket for health care

This data is frightening. The retirement system is severely broken. Too many times, the public policy behind the retirement system has been abused by tax policy. We are left with retirement plans being a toy for Congress to make bills seemingly budget neutral. 

The ability to retire is part of the 21st century American Dream. This data suggests that the retirement part of the dream may be just that -- a dream.

Not pretty ...

SAFE Retirement Plan -- A Paper from the Center for American Progress

The Center for American Progress (CAP) released a paper entitled American Retirement Savings Could be Much Better. For readers interested in the topic of retirement savings, I would highly recommend a read or at least a perusal of the paper. The authors are Rowland Davis, a well-known actuary who very clearly does have the training and experience necessary to undertake such a study and David Madland, a commentator on the economy, unions, retirement policy and public opinion. Not having the same background as Dr. Madland, I am not in a position to judge his background and experience, but as the paper is well-founded, I will presume that he too is highly qualified to opine on this topic.

Essentially, the authors propose what is often referred to as a collective savings or collective defined contribution plan. Under such a plan, in a nutshell, a worker would enroll in a SAFE (secure, accessible, flexible, and efficient) retirement plan. This plan would have all of these characteristics (not an exhaustive list):

• Workers would opt into a SAFE Plan of their choosing
• Employers could choose to contribute or not
• Plan assets would be professionally invested at what would currently be considered very low levels of fees
• Workers' accounts would get the returns on the professionally managed pools of assets subject to a floor and a ceiling (in combination, referred to as a collar)
• At retirement, the account balance would be converted to an inflation-adjusted annuity

Let's consider what the authors have created here. Essentially, it's a contributory multiemployer cash balance pension plan with a set of features not currently permitted under the Internal Revenue Code for qualified plans. 

What a novel concept! The authors have chosen to separate retirement policy from tax policy. For this, they are to be applauded. Combined with the access that CAP has to legislators, this has far more value than when your poor little blogger (me) spews forth similar ideas ("public policy" ramblings in this blog). 

Frankly, this is a pretty cool idea. It has these attributes that are very positive:

• The plan is portable
• It provides for retirement income
• It reduces "leakage" (the authors would have us believe, according to my reading, that it eliminates leakage and this might be the case if workers never experienced bouts of unemployment, but alas, they do)
• The retirement income is somewhat protected against inflation
• Employers can be employers of choice by contributing to their workers' SAFE Plans

What I like best about the proposed design, however, is that it violates the current Internal Revenue Code in oh so many ways. The retirement plan design is founded on retirement policy. Note the symmetry!

I would be remiss if I did not point out some of the issues that I take with the authors' work. In their paper, in at least one of their models, they appear to assume historical equity and fixed income returns going forward, but 2% inflation. In my opinion, this set of assumptions is not internally consistent. In my lifetime (it started in late 1957), there have been only 12 years out of the 55 from 1958 through 2012 in which inflation was less than 2% while in the other 43, the rate of inflation exceeded 2% annually (you can see the data here). 

Assuming that workers' salary deferrals to a SAFE Plan would be continuous from entry until retirement at age 67 is unrealistic (rates of unemployment are high). However, regardless of the assumption, SAFE Plans would be safer for workers (by a lot) than the current mostly 401(k) system that we have. Again, that is the point that the authors seek to make and they make it well.

Finally, in giving workers the option to reduce the automatic contribution to SAFE Plans, the authors tempt reality. To think that the typical worker will have the discipline to continue contributing at the appropriate level in times of hardship, need, or even desire to spend, is not, in my opinion, realistic. Once again, however, the results inherent in SAFE Plans far outpace those in the current retirement system.

The financial economists in the actuarial profession will scoff at the assumed equity risk premium. This is a debate on which both sides are fervent and will likely never agree. Regardless of who turns out to be correct, however, SAFE Plans will outperform any other equal cost plan currently permitted under the Internal Revenue Code.

Unlike most (in my experience) papers on retirement policy published by think tanks, CAP has engaged a highly qualified and experienced retirement actuary. Mr. Davis has made a set of actuarial assumptions and has disclosed the key assumptions. The paper has been reviewed by a group of individuals, two of whom are credentialed actuaries. I rue that several other of the reviewers are life-long Congressional staffers and or think tank workers, but I did not fund the work, so I have no say.

Ardent Republicans in my readership will have the inclination to look for flaws in the paper. Fervent Democrats will likely be in awe of the wondrous solution. I choose to read it with both a jaundiced eye and an open mind. It's a significant step in the right direction.

Compliance or Policy?

This is going to be a fairly short post, I think. I want to talk a bit about what should be the greater influence on benefit program design -- compliance or policy?

Right now, and especially as PPACA (health care reform or ObamaCare, if you prefer) is starting to exert its influence, it seems that most benefit program design is structured to facilitate compliance with the myriad of laws that Congress has passed since ERISA was signed 38 years ago. Just think, you provide a big health care benefit, you pay a Cadillac Tax. Your NHCEs can't afford to defer to your 401(k), your HCEs don't get to benefit. You would like to provide your employees with retirement income, but you cannot stand the volatility in corporate cash flow and P&L of a defined benefit plan.

Seems wrong, doesn't it?

So, even to the extent that you have a policy that is governed by things like true long-term cost and what is right for your employees and your business, you are unable to implement that policy while being in compliance.

Seems wrong, doesn't it?

Of course, it's wrong, but the people who make the laws don't seem to get it. They don't believe in benefits policy. They don't believe in retirement policy. They believe in tax policy and gerrymandering the tax code to make it work, often at the expense of corporations (large and small) and their employees.

Seems wrong, doesn't it?

Senator Harkin Proposes Changes to Retirement System

As Congress approached its August recess, Senator Tom Harkin (D-IA) released a position paper entitled “The Retirement Crisis and a Plan to Solve It.” The release of the paper is notable because as the Chairman of the Senate Health, Education, Labor & Pensions (HELP) Committee, Harkin is perhaps the most influential legislator in the entire Congress with respect to qualified retirement plans. Here, I will give you an overview of Senator Harkin’s paper with some commentary. Given his position, should the Democrats retain control of the Senate and the White House, this paper likely signals a directional shift for the retirement industry.

Senator Harkin proposes two very significant changes:

• Development of Universal, Secure, and Adaptable (USA) Retirement Funds 
• Changes to the Social Security structure designed to better finance the program while providing better benefits for the lowest earners and inflation protection better geared to inflation as it affects senior citizens

USA Retirement Funds

Senator Harkin is concerned that so many Americans have essentially no retirement savings including any employer-sponsored retirement plans. The solution, as he sees it, is to give employers a choice of sponsoring their own retirement plans or putting their employees into a USA plan. Plans that are entirely voluntary for employees (401(k) without auto-enrollment or without a sufficient employer match) would not suffice as employer-sponsored. To the extent that they were to go the route of the USA plan, here are the key features as I read Harkin’s paper:

• ·         Auto-enrollment through payroll deduction
• ·         USA Retirement Funds would be professionally managed
• ·         Regions, industries, or collective bargaining agreements might have default funds
• ·         Benefits would be 100% portable
• ·         Retirement benefits would be payable as annuity with survivorship rights for beneficiaries

Senator Harkin notes in his paper that USA Retirement Funds will compete with each other keeping costs low. They will be subject to significant disclosure requirements to ensure transparency.

Social Security Changes

As we all know, the Social Security system is projected to run into a shortfall situation at some point between 20 and 40 years out depending upon which forecast we look at. Senator Harkin’s proposal is designed to address this while improving benefits for certain retirees at the same time. Here are the three key points of his proposal with respect to Social Security:

• ·         Eliminate the Social Security Wage Base (currently $110,100) so that higher earners and their employers would no longer have the phase-out of OASDI taxes. Currently, employees and their employers pay 6.2% of pay up to the Wage Base into Social Security and 1.45% of all pay into the Medicare (HI) part of the system.
• ·         The existing methods for calculating Social Security benefits use a progressive three-tier approach. Currently, 90% of a person’s Average Indexed Monthly Earnings (essentially, their average inflation-adjusted compensation over their career) up to $767 is added to two other components in calculating the benefit. Under Senator Harkin’s plan, that 90% would phase up to 105% over a 10-year period. What this would mean is that low wage earners would receive a larger benefit from the Social Security in retirement than the pay they had been receiving from their employer.

·         Today, the annual inflationary adjustment for Social Security beneficiaries is based on the increase in the Consumer Price Index for all Urban Wage Earners (CPI-W). This index would be replaced by the CPI-E, the Consumer Price Index for the Elderly which places significant emphasis on the rising costs of health care.

Another Viewpoint on Retirement -- Has the 401(k) System Failed?

Our Ridiculous Approach to Retirement - NYTimes.com

Last Sunday, Theresa Ghilarducci, a career retirement policy person and now Professor of Economics at the New School for Social Research wrote this interesting piece for the New York Times. In it, Ms. Ghilarducci's penultimate paragraph reads as follows:

It is now more than 30 years since the 401(k)/Individual Retirement Account model appeared on the scene. This do-it-yourself pension system has failed. It has failed because it expects individuals without expertise to reap the same results as professional investors and money managers. What results would you expect if you were to pull your own teeth or do your own electrical wiring?

In the article, she makes some very interesting points. Most people underestimate what they need to live well in retirement. One of her observations, however, is exceedingly important and rarely raised; that is, the probability that your last dollar will run out on the day you die is essentially zero, and if we take it to the moment you die, that probability, for the math geeks out there, is approximately epsilon (for you non-math geeks, that means it's not going to happen).

Put differently, this implies that you need to have more money in savings than you will need. But, all this is based on life expectancy. That's a median. Fully half the population will outlive that median. So, they need more. Do you know if you are part of that half? By how much will you outlive that life expectancy? Don't know that either, do you?

Clearly, the solution lies in lifetime income options, preferably with inflation protection. Where can you find that? It's tough. You can take your assets and find an annuity salesperson who will sell you such a product, although there aren't many such products around. And, given that there aren't many products, they are not priced fairly to the consumer. Then, there is the in-plan lifetime income option. But, I spoke to representative from a large 401(k) provider the other day who said that their research suggests that neither plan sponsors nor their employers currently want them.

So, how do you get lifetime income options? Defined benefit plans? You remember them, they used to be popular. Has anyone considered a low-risk (for the employer) defined benefit solution that might help to solve this problem? Sadly, the law has made this very difficult. But, consider this hypothetical design:

• Cash balance style
• There is a non-elective employer "pay credit" and a matching employer pay credit on employee contributions (this is not currently allowed)
• Inflation-protected annuities as a distribution option

What do you think? I'd love your comments, pro or con, serious or even with a little humor.

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.

It's Not Just Math

What is so special about $1 million? Is it that much more special than $999,999? Not to me. They would both represent a significant amount of income for one year -- more than I ever expect to see. What is so special about a defined benefit pension plan having a funded status (AFTAP) of 90% or 92% or 94% or 96% or 100% instead of 0.01% less than any of those magical percentages? Nothing that I can see.

Yet, much of public tax policy seems to revolve around hitting or missing these thresholds or cliffs as I think of them. Make the mark and all is well. Miss it by the smallest of margins and you fall off ... perhaps to your death.

I'm sorry. Cliffs may exist in the landscape, but putting them into tax policy is just plain stupid. I repeat, it's just plain stupid. You want to know what I really think about cliffs in tax policy? Let's move on.

I decided to read the President's version of the American Jobs Act of 2011 (AJA). If you want your own copy, you can get it at http://www.whitehouse.gov. It's 199 pages and it's not a fun read. It doesn't have a real good plot; in fact, there is no mystery in this thriller.

I am going to focus on something specific here, and I am going to tie it back to 401(k) plans. According to the current version of AJA (not Steely Dan's version or Louie Gohmert's version), a married couple filing jointly becomes more fortunate when their combined earnings equal or exceed $250,000. By my quick reading, it would suck to have combined earnings of $250,000. $2,500,000 would work out just fine, but if my earnings (combined with those of my wife) were exactly $250,000, I would be looking to find a way to give up one of those dollars to get to $249,999.

Because of the cliff-like nature of tax policy, trust me, the couple earning $249,999 would be far more fortunate than the couple earning $250,000. Their deductions (also known these days as loopholes) wouldn't go away.

What is one of those deductions? How about the one that you get for deferrals to a 401(k) plan or the one that you get for pre-tax payments of health care premiums? At $249,999, you still seem to get them; at $250,000, to quote Phil Rizzuto (that is scary), those deductions will be gone, gone, goodbye. So, after figuring in the tax bill, earning one dollar more costs you a whole bunch. That is just plain stupid.

To quote President Obama, "[I]t's not class warfare; it's just math." President Obama is a very smart man. He taught constitutional law, and I presume that he knows far more about it than I do. However, I taught math and he didn't. This is not just math (I leave the proof that it is or is not class warfare to the reader as that's what authors do in math books).

When there is a literal incentive to earn less or a disincentive to earn more, that's not just math. It's stupid. When a cliff causes you to be worse off than if you had successfully begged for a $1 lower salary, that's stupid.

Some of my readers tend Democrat, some tend Republican, some do not tend at all. This is not about that, however. You can tax the high earners more or not as you choose, but as for the AJA, it's not just math!