Desire to Move to Lifetime Income Options -- Is It Real?

I read an article this morning that tells me, among other things, that two in ten defined contribution (DC) plan participants plan to use some portion of their plan assets to purchase lifetime income products. I don't dispute the research that was done, but I absolutely dispute that behaviors will be as the data imply.

Before you read on, I want to be clear. Any criticism that I have here is not of the author. The piece does an excellent job of explaining what the data say. My criticism is also not of the data collection. The Employee Benefit Research Institute (EBRI) asked legitimate questions and reported the answers that they received.

But, this is a case where I posit that a perfectly good interpretation of perfectly good data is likely to not be a good predictor of future behaviors, at least not as the law exists today. What we need to help these data to be a reliable predictor is a statute that is focused on retirement policy not on the assumption that small groups of people will abuse the Tax Code. And, once that statute works, we need plan designs that give well-meaning plan participants the ability to customize their individual retirement income streams to meet their own needs without worry that somehow they will fall prey to regulations that were written to stop abuse by a few. (For the retirement and tax geeks reading this, yes, sections like 401(a)(9), I mean you.)

Is this newfangled design DC? Maybe or maybe not. Is this newfangled design defined benefit (DB)? Maybe or maybe not. Why do we really need such a broad distinction?

I'll return to the design issues later, but first I am going to make a u-turn back to my comment about these data as predictors.

Yes, two in ten DC plan participants would like to get some lifetime income or longevity protection from their DC plans. But, what options are available? Generally speaking, whether they are in plan or out of plan, they are retail priced annuities (meaning they are priced favorably for the annuity provider and therefore unfavorably for the annuity buyer). There are traditional annuities and there are qualified longevity annuity contracts (QLACs). The experience in the marketplace thus far (anecdotally) is that participants will pay anywhere from 15% to 40% more for these annuities from DC plans than would be considered actuarially equivalent to a lump sum in a DB plan. Insurers need to be both risk-averse and profitable and therein lies a difference. DB plans, on the other hand, are intended, generally speaking, to provide optional forms on an agnostic basis.

So, how do we get there? As I said earlier, changing the statute to allow common-sense streams of income for participants is a great first step. Then we need a new type of design. To me, it probably doesn't fall into the current, common notion of DB or DC.

Let's call it the Plan of the Future.

And, once those common-sense options are available, my prediction is that far more than two in ten participants will want some amount of lifetime income whether it's from DC plans, DB plans, or just qualified retirement plans.

Opinion: American Workers Need Pensions and They Should Look Like This

Since I last blogged, I've seen a lot of survey data. Among the very compelling themes has been that Americans are afraid that they will not have enough money with which to retire. Those fears are well founded for many.

As I've written here many times, the 401(k) plan was never intended to be the primary retirement source of retirement income for American workers. Neither was Social Security. Rather, Social Security was intended to be a supplement to bridge people for what was usually just a few years of retirement before death. Section 401(k) was a throw-in in a late 70s tax law that was suddenly discovered. It was intended to give companies a way to help their employees to save more tax effectively. And, remember, in the late 70s, the norm was that whatever company employed you at age 35 was likely to be your last full-time employer. ERISA had recently become law and most American workers had defined benefit pensions. These plans were designed to assist employers in recruiting and retaining employees.

Then, again, as I've written many times, along came change through the government and through quasi-governmental organizations. Employers didn't like the mismatch between cash flow requirements and financial accounting charges. New pension funding laws, beginning in 1987, were designed not to ensure responsible funding of pension plans, but to provide an offset to tax expenditures (a fancy name for tax breaks and government overspending). Looking at it from the standpoint of someone in Congress trying to decrease tax expenditures, if you can decrease required company contributions, you decrease their tax deductions, and thus cut those evil tax expenditures.

Nearly 30 years later, pensions have tried hard to go the way of the dinosaur. The fact is, however, that there are still lots of defined benefit pension plans out there. But, they don't look the same as they did 30 years ago. The laws have changed, creative minds have been at work, and new and better designs have emerged.

American workers generally should have employer-provided defined benefit pension plans. But, since these creative minds have been at work, what exactly should these new plans look like?

• While they offer a sense of stability in retirement, annuity payments do not appeal to many Americans and they do not necessarily understand them. So, while all defined benefit plans must have annuity options, they should also have lump sum options.
• The plans should not be "back-loaded" (a term that means that most of your accruals and therefore cost to your employer emerges late in your career). The typical final average pay plan of yesteryear was designed so that most of your accruals occurred close to or after you were eligible to retire. This made some sense when you spent your whole career with one employer. But, in 2016, that very rarely happens. So, plans should accrue benefits fairly ratably.
• Benefits should be portable. That is, you should be able to take them with you either to an IRA or to another employer. This works best if there is a lump sum option through which you can take a direct rollover and maintain the tax-deferred status.
• Employer costs should be predictable and stable. This can be achieved when there is no longer a mismatch between assets and liabilities in a plan.
• Employers should see that plan assets are professionally managed, but fluctuations in asset returns from those that are expected can be borne by plan participants.

This sounds like pension nirvana, doesn't it? Such plans and designs can't possibly exist.

Well, they do. 

The plan design that accomplishes this is often known as a Market Return Cash Balance Plan (MRCB).

While an MRCB carries with it all of the required characteristics of defined benefit plan and it looks a lot like a 401(k) or other defined contribution plan, it brings with it additional benefits. It satisfies all of the bullets I've outlined above. Budgeting gets easy and predictable. There is no "leakage" due to sudden expenses when a participant's car decides to break down or an unexpected flood ravages their house.

An MRCB is very suitable to be a primary retirement plan. You want to save a bit extra? That's what your 401(k) plan is for. 

If you are an employer and you're reading this, you really need to know more, don't you?

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 ...

Will the Super-Congress Kill Your Benefits?

If you haven't been hiding under a rock, you know that Congress reached a budget/debt deal last week that was signed into law by the President. Well, they sort of reached a sort of deal.

They increased the debt limit by more than $2 trillion and they cut spending by about $2.5 trillion. Except that they didn't. You see roughly $1.5 trillion of that savings is yet to be decided. The dreaded Super-Congress (three each of Senate Democrats, House Republicans, Senate Republicans, and House Democrats) is charged with coming up with a plan to find that other piddling amount. If they can't do it by November 23 of this year, then the nuclear option kicks in (stop your wishful thinking, nothing inside the Beltway will be nuked). In oversimplified terms,  the nuclear option will make pre-specified cuts adding to roughly $1.5 trillion. And, those pre-specified cuts will come to a large extent to each party's sacred cows -- defense spending and entitlement spending.

So, somewhere between November 22 and November 23, the Super-Congress will miraculously reach agreement. Remember, you heard it here first.

Thus far, we know the names of 9 of the 12 members of the Super-Congress (the 3 House Democrats are yet to be named). Perhaps more important, we know the names of the co-Chairs: Senator Patty Murray (D-WA) and Representative Jeb Hensarling (R-TX). To say that there is common ground between these two is roughly akin to saying that Kennedy and Kruschev were best friends. I'll let you guess on the details.

So, why am I writing about this in a blog that is usually devoted to benefits and compensation? I'll get to that soon, but I am glad that you asked.

As the Super-Congress gets named, various members have deigned to give interviews to the media. The Democrats say that entitlements need to stay as they are and that the wealthy need to pay more taxes. The Republicans say that the defense budget is critical and that new taxes are not on the table.

Where they agree, though, is that we have too many tax loopholes. Their may not be agreement on what constitutes a loophole, but you can't have everything.

I don't recall where, but I read somewhere that the three largest tax expenditures are these (in no particular order):

• The mortgage interest deduction
• The employer deduction for health benefits for employees
• The combination of the employer deduction for retirement benefits for employees and the tax-free build-up of assets in trusts for qualified retirement plans

The first one, in my opinion, is a goner. Not in its entirety, but above some limit, there will be no tax deduction for mortgage interest. And, there will be no deduction for interest on any but a primary residence. Again, in my opinion, as this has been floated before without tremendous resistance, this seems obvious.

The other two, they are in serious trouble. And, if either or both suffer, so will you, the American worker.

Let's use an example to illustrate. Suppose your cash compensation is $100,000 per year. Let's estimate then that the total cost of your employment to your employer (before tax deductions) is $140,000 (this number may be high or low, but it's not a bad representation). Presently, your employer gets a tax deduction for virtually every dollar of that. So, assuming a 35% marginal tax rate, that means that after $49,000 in tax deductions, you cost your employer $91,000 per year.

Are you with me?

Again, in very round figures, suppose your health and retirement benefits cost your employer $15,000 per year (before the effects of tax deductions). At 35%, the deductions for that will be $5,250. So, eliminating these deductions will cost your employer $5,250 (with respect to your employment). Do you think you are going to continue to get the same benefits? Think again. For most of you, the answer is no, or perhaps it's NO!

Your employer is going to cut its contribution to your benefits to save that $5,250. So, the value of your employment package will decrease by about $5,000 on a baseline of $140,000. That's a little more than 3.5%. Oh, you don't think that sounds like much? In this economy, how long does it take you to get a 3,5% pay increase? For many of you, that could be two or three years.

So, how can this happen. Well, the Republicans will swear up and down that this is not a tax increase and they will tell you that they have held to their pledge to not increase taxes. The Democrats will fight hard to ensure that this change does not apply to the lowest paid workers and that its effect progressively increases as a worker's pay increases, probably phasing in completely somewhere around $150,000 of cash compensation.

And, the chosen twelve will shake hands and know that they have saved their sacred cows, and each side will go back to its constituency and say that it has won. Don't believe them for a second. The losers will be you and me. The losers will be the American workers who "get up every morning to the alarm clock's warning, take the 8:15 into the city" (I know, Bachman-Turner Overdrive was a Canadian band, but the lyrics fit).

Remember, you read it here first. 

Most Blame Decline in Pensions on Congress

The National Institute on Retirement Security (NIRS) surveyed American workers about their retirement. While I don't find the results of the survey surprising, in general, I did find it interesting how and where the blame for worker's anxiety about their retirement is placed.

Here are some of the highlights of the survey, along with some (probably pithy) commentary:

• 83% of Americans are concerned about their retirement. That is the biggest number that I have ever seen for this statistic.
• 84% say that the current economy is an impediment to their preparations or their ability to prepare for retirement. While this is surely true, this is the first period since the passage of ERISA where employer-provided retirement benefits have been cut so drastically at the same time as the economy has plummeted. In previous recessions (although the recession of about a decade ago foretold how employers would likely react to this one), employer-provided retirement benefits have been much more sacred.
• Only 11% of Americans expect their retirement to include things like travel, restaurants and hobbies. On the other hand, 34% will be happy to just get by.
• Nearly 90% of those surveyed believe the US private retirement system is flawed.
• 77% are of the opinion that the downfall of pensions has made it harder to live the "American Dream."
• Roughly 80% of Americans think Congress doesn't understand how difficult it is to prepare for retirement, while a full 80% think that Congress needs to do more to help Americans to be able to prepare for a secure retirement.

I find the last bullet most interesting. 37 years ago, after many years of debate and revisions, Congress passed, and President Ford signed into law ERISA. That was the dawning of the golden age for pensions in America. Not only did the number of employer-sponsored pension plans increase, but those pensions were far more secure than they had been previously. But, we couldn't leave a good thing alone.

Bring the alphabet soup of laws affecting retirement plans to the rescue, so to speak. REA, passed in 1984 raised pension costs significantly. SEPPAA, passed in 1986, made it more difficult to terminate a plan once you started one, and, combined with the Tax Reform Act of 1986, made certain that the surplus in a pension plan belonged mostly to the government in the event that an employer chose to terminate a plan. OBRA 87 added pointless volatility to pension plans. It also signaled the beginning of the era in which Congress showed that it is far better in choosing reasonable actuarial assumptions than people trained (and certified through examination) as actuaries (of course Congress knows more, they know more about everything). Various laws throughout the 90s and early 2000s created further turmoil. And, all along, the accounting profession also tried to lay claim to thinking that it knows more about pensions than the people with specific training. And, finally, we got the worst named law in history: the Pension Protection Act of 2006. It has done more in a short period of time to ensure that the majority of Americans will not accrue a pension than any law previous to it. Yes, it has done a wonderful job of protecting the PBGC, but as I have said before in this blog, rather than protecting private pensions, it has decimated them.

Well, according to this survey, Americans may not know how it happened, but they do seem to know, or at least believe that the fault lies with the Fools on the Hill (Congress). But, they think they fixed the problem.

And, so it goes ...

Text Of Lifetime Income Disclosure Act

Here it is: http://www.gpo.gov/fdsys/pkg/BILLS-112s267is/pdf/BILLS-112s267is.pdf

Senators Introduce Lifetime Income Disclosure Act

In a bipartisan effort, Senator Jeff Bingaman (D-NM), along with co-sponsors Herb Kohl (D-WA) and Johnny Isakson (R-GA), has introduced Senate Bill 267, the Lifetime Income Disclosure Act. I would provide you with a link to the actual bill language here, but there is this little problem: it's not yet made it to the Government Printing Office (GPO), nor has it made it to Senator Bingaman's web site. For those who want to read the actual language in the future, I suggest you go to the Library of Congress web site: http://thomas.loc.gov and search on S 267.

Readers do not want the delay inherent in the GPO. If you are here, you want your news now. So, without further adieu, away we go (my tribute to Jackie Gleason). Sponsors of defined contribution (DC) plans will be required to provide participants with annual statements that are patterned after Social Security statements. They will be required to show a participant's projected lifetime income based on a number of assumptions (none of which, IMHO, will actually come true). To relieve plan sponsors of "material burden", the Department of Labor (DOL) will be directed to provide a model disclosure as well as tables to assist plan sponsors in preparing these statements.

This could be interesting. If the assumptions that are mandated or recommended by the DOL are reasonable, roughly half of plan participants will fail to have balances sufficient to support the disclosed annuities. Bring on the cavalry -- plaintiff's bar. But, who will they sue? Plan sponsors? The DOL? Congress?

This is a step in the right direction, though. A bill like this will at least get people thinking about how much annual income their account balances might provide. But, this is at best Step 5 or 6. Step 1 needs to be in the schools. By the time a participant gets into the workforce, he or she needs to have enough financial literacy to understand things like this. But, that's a different rant for a different day. In the meantime, I applaud these three senators for their efforts and I'll keep you informed as this bill moves along.

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.

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.

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