Wake Up and See the Light, Congress!

Congress has a once-in-a-generation opportunity. Since its first major overhaul in 1922, Congress has seen fir to make earth-shaking changes to the Internal Revenue Code (Code) once every 32 years. 1922. 1954. 1986. And, while it seems that they may be one year early this time, they are pitching tax reform once again.

The concept of qualified retirement plans as we know them today comes from the Employee Retirement Income Security Act of 1974 (ERISA) signed into law that Labor Day in 1974. Since that time, there have been relatively few changes to the Code affecting retirement plan design. And, frankly, most of them have come on the 401(k) side. In fact, Section 401(k) was added to the Code after ERISA and since then, we have been blessed with safe harbor plans, auto-enrollment, auto-escalation,Roth, and qualified default investment alternatives (QDIAs). Over the same period, little has been codified or regulated to help in propagating the defined benefit plan -- you know, that plan design that has helped many born in the 40s and early 50s to retire comfortably.

Isn't this the time? Surely, it can be done with little, if any, effective revenue effects.

Since ERISA, there have been really significant changes in defined benefit (DB) plan design including the now popular traditional cash balance plan, the even better market return cash balance plan, pension equity plan, and less used other hybrid plans. And, DB plans have lots of features that should make them more popular than DC plans, especially 401(k) plans.

• Participants can get annuity payouts directly from the plan, thereby paying wholesale rather than the retail prices they would pay from insurers for a DC account balance.
• Participants who prefer a lump sum can take one and if they choose, roll that amount over to an IRA.
• Assets are professionally invested and since employers have more leverage than do individuals, the invested management fees are better negotiated.
• In the event of corporate insolvency, the benefits are secure up to limits.
• Plan assets are invested by the plan sponsor so that participants don't have to focus on investment decisions for which they are woefully under-prepared.
• Participants don't have to contribute in order to benefit.

But, they could be better. Isn't it time that we allowed benefits to be taken in a mixed format, e.g., 50% lump sum, 25% immediate annuity, 25% annuity deferred to age 85? Isn't it time that these benefits should be as portable as participants might like? Isn't it time to get rid of some of the absolutely foolish administrative burdens put on plan sponsors by Congress -- those burdens that Congress thought would make DB plans more understandable, but actually just create more paperwork, more plan freezes, and more plan terminations?

Thus far, however, Congress seems to be missing this golden opportunity. And, in doing so, Congress cites the praise of the 401(k) system by people whose modeling never considers that many who are eligible for 401(k) plans just don't have the means to defer enough to make those models relevant to their situations.

Sadly, Congress prefers to keep its collective blinders on rather than waking up and seeing the light. Shame on them ...

New Trends in the 401(k) World

Shortly after the passage of the American Taxpayer Relief Act of 2012 (ATRA), Aon Hewitt did a pulse survey of more than 300 large employers (presumably from their client base, but the press release doesn't seem to specify) on 401(k) plans. Here were some of their key findings:

• 49% of respondents currently do not offer Roth provisions
• Of those, 29% are very likely or somewhat likely to add Roth provisions in the next 12 months (this would bring the percentage who do not offer Roth provision down to about 35% of the total)
• Of the new adopters, about 76% will add in-plan conversion (from traditional to Roth) features
• Approximately 53% of companies that currently allow Roth contributions but do not currently offer in-plan conversions will begin to allow them

Personally, I am pleased to see this trend. For the life of me, though, the only good reasons I can see to not offer both of these features are these:

• HR has too many other things on their plate and implementation of these is not a high enough priority to implement in 2013
• The company is particularly paternalistic and worries that because Roth accounts have earlier distributable events than traditional 401(k) accounts that participants will not use them for retirement
• Employees have not asked for them (I think this is not a good excuse because many employees will not have heard of the opportunity)
• Employers have not heard of these changes (shame on them, they should be reading this blog, of course)

The employer-sponsored retirement plan world has changed from one largely of employer responsibility to largely one of employee responsibility. For employees to someday retire, since very few who don't save in employer-sponsored retirement plan save elsewhere, those employees will need to begin saving at young ages and save responsibly and consistently. The more tools they have available to them, the more likely they are to do it, and that is good for our future.

We Have a Fiscal Cliff Deal

It had to happen. If it didn't, the sun might not have risen. Perhaps it's what the Mayans anticipated so many years ago -- the fiscal cliff. Well, through the last-ditch efforts of Congress (you do know that a collection of baboons is called a congress, don't you?), we have 157 pages of legislative contortion that keeps the country from plunging off that cliff.

Who gets helped? Who gets hurt? Well, they say that if nobody is happy, then there really was compromise. In this particular case, the compromise was a combination of tax cut extenders and a few spending cuts. Most of what's in the bill doesn't matter to my typical reader. In fact, most of it doesn't apply to any reader that I know. But, since you're here and reading, I'll let you in on a few things that might.

• FICA taxes (the OASDI part) are going back up to 6.2% of pay up to the wage base. For those who are counting, that's a 2% additional tax compared to last year on the entire income of most working Americans. But, if we kept it at 4.2% of pay, Social Security was going to run out of money really quickly.
• Most Americans have no increase in their marginal tax rates. Unless you are (depending upon your filing status) a single person with adjusted gross income (AGI) in excess of $400,000, a head of household with AGI more than $425,000, or a couple filing jointly with AGI exceeding $450,000, you still benefit entirely from the Bush era cuts in marginal income tax rates.
• If you are fortunate enough to be a beneficiary of the estate of someone who is unfortunate enough to die, estate tax rates are higher than they have been the last few years, but not as high as they were prior to 2001.

These were all considered to be tax increases by those who were worried about counting tax increases versus spending cuts. But, then there's this beauty for people who are wondering where the spending cuts are coming from. The ability to convert traditional IRA, 401(k), 403(b), etc. accounts to the Roth variety has been made permanent, or at least until a future law makes this ability disappear. 

This is a savings? Of course it is. Readers of this blog know of my dislike for the required methodology used to score bills by the Congressional Budget Office (CBO). They look at the next ten years on a static economic basis. Since you have to pay taxes on the converted amount when you convert your Roth, and the taxes that you would have paid upon retirement on the traditional account would often have not been paid for more than years into the future, this is scored as a money-saver.

The message here is that when you read in the media that there are spending cuts in this bill, take it with a grain of salt.

Oh yeah, there are also tax cut extenders for some of the usual suspects: Hollywood, NASCAR, and green energy among them. 2013 is off to a rousing start.

The 1-Year FICA Cut and 401(k) Plans

Every working American subject to FICA taxes will see a pay increase in 2011 of 2% of pay up to a maximum savings of $2,136. For those who have not been saving enough in their 401(k), I am going to suggest that they increase their rate of deferral to that plan. It doesn't matter from a FICA standpoint whether you put that money in as pre-tax, Roth, or after-tax, as money put into a 401(k) plan by an employee is FICA taxable.

Suppose employees choose to contribute more. Then, employer matching contributions will increase. Are companies budgeting for this? Are they even thinking about it?

This all goes back to risk management. Is this a risk that has been considered? Where will the money come from?

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.

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.

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