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?

How Companies Can Piss Off Shareholders

I thought this might be a provocative title for a blog post: "How Companies Can Piss Off Shareholders". Frankly, if you are expecting a full discourse on all the ways this can be done, you've come to the wrong place. The seminal piece on this is undoubtedly the ISS (Institutional Shareholder Services) 2011-2012 Policy Survey Summary of Results. And, for that matter, if you really want a more thoughtful analysis of the entire survey, I would direct you to Mike Melbinger's latest blog post on this topic.

ISS would never say anything like the title of this post. And, Mike Melbinger, while I love his blog, tends to be more politically correct than yours truly. If you came here to read about this, then you are looking to see someone fall. Knives in the back are fair game. So are sucker punches below the belt. Here, the only rules are the Truth According to Me (apologies to John Irving and T.S. Garp).

So, between the strategically chosen dates of July 6 and August 26 of 2011 (after people came back from celebrating our nation's birthday and before they left to celebrate labor (the kind that you get paid for, not the kind that causes expectant mothers to scream)), ISS asked a whole bunch of questions of both investors (institutional shareholders) and issuers (companies that issue proxies to their shareholders).

Before getting into the nitty gritty, though, I feel the need to digress. Has a body as educated and seemingly intelligent as ISS not made it through 3rd grade math? In their introductory remarks, ISS notes that "[M]ore than 335 total responses were received. A total of 138 institutions responded. ... 197 corporate issuers responded ... ." I got out my handy-dandy calculator which in my case sits somewhere north of my neck (traditional calculators have a tendency in my world to hide themselves under stacks of paper, but my calculator always seems to live in about the same place, covered with some hair in strategically chosen places) and added 138 to 197. Hmm? The total was 335. It was not more than 335. Come on, ISS, this is simple stuff. Editors, though, have a problem with starting sentences with a number, so they use silly terms like more than to mean exactly.

OK, enough on that rant ...

In any event, ISS does an outstanding job with their report. Right up front, they summarize key findings. And, for the upcoming proxy season, the #1 governance issue cited by 60% of investor respondents and 61% of issuer respondents is Executive Compensation. Said differently: if a company wants to piss off its shareholders, the #1 way is to compensate its executives in a manner or amount that does not align with shareholder goals. Other top issues for shareholders were Board independence, shareholder rights, and risk oversight, in that order. For companies, the only issue other than executive compensation receiving more than a 30% vote was risk oversight.

Later on, ISS drills down (I've never used that term in writing before, but I felt the need today). Some of the findings that I found interesting were these:

• 62% of investors find it very relevant (negatively so) when executives are paid significantly higher than their peer group.
• 88% of investors find it very relevant if pay levels have increased disproportionately to the company's performance.
• While issuers generally do not feel compelled to respond to a say-on-pay vote until the dissenting vote has approached or reached 50%, nearly half (48%) of investors feel that an issuer should provide an explicit response when the no votes reach 20% or even less.

Institutional shareholders are very serious about say-on-pay. Companies that ignore this are seeing two phenomena -- contested elections of Directors and shareholder lawsuits against the Board of Directors. 

For companies that may be headed down a path of compensation that could get a lot of no votes, they need to do a lot of planning and explain their decisions up front. Right up there near the top of problematic pay practices are egregious SERPs. Sometimes, they are justifiable, and other times, ...

Caveat enditor!

The Numbers are Simple, But They Don't Add Up

We're in the early stages of open enrollment season. Workers are not happy. Is it 2011, or is it just a redux of 2010, 2009, 2008, 2007, etc? We're going to keep it short, but simple. A few of the numbers are made up, but they are not unreasonable.

Sneezy works for Snow White Company. He is married and a father of two children, Dopey and Bashful. In 2011, Sneezy's salary from Snow White was $100,000. As Snow White has not given raises for several years, it has promised Sneezy a 3% increase for 2012. Sneezy was happy about that until he saw what was going on with his health care premiums.

You see, Snow White provided some communication to its employees. In that communication, they used some fancy words like competitive pressures, margins, and cost-sharing. Sneezy had read something about cost-sharing increasing from 20% to 30% for employees and removing the subsidy for other family members that had been at 25%. Sneezy had heard on TV while he was waiting for his favorite show to come on that something called health care inflation was 10% for the year.

So many numbers! Sneezy didn't like math when he was in school and all these percentages boggle his mind.

He went to see his brother, Doc, to ask him how all this would affect Sneezy and his family. Let's look together.

2011
Salary                                              100000
FICA Taxes @ 4.2%                         (4200)
                                                         95800
Federal Income Taxes @20%           (20000)
                                                         75800
State Income Taxes @5%                  (5000)
                                                          70800
Health Care Premiums (see below)      (6360)
                                                          64440
HI (Medicare) Taxes @1.45%            (1450)
Remaining Cash                                  62990

Health care premiums were $1000 per month (400 for the employee and 600 for the other family members). Snow White paid 80% of the amount for the employee and 25% of the amount for the rest of the family or $470 per month in total, leaving Sneezy with premiums of $530 per month or $6360 per year.

2012
Salary (with 3% raise)                     103000
FICA taxes @ 6.2                            (6386)
                                                        96614
Federal Income Taxes @ 20%        (20600)
                                                        76014
State Income Taxes @ 5%                (5150)
                                                        70864
Health Care Premiums (see below)    (9504)
                                                        61360
HI (Medicare) Taxes                         (1493)
Remaining Cash                                59867

Health care premiums with the 10% health care inflation had increased to $1100 per month (440 for Sneezy and 660 for his additional family members). The change in cost-sharing has Snow White paying just 70% of that first $440 or $308 per month leaving Sneezy to pay $792 per month or $9504 per year.

Poor Sneezy. He got a $3000 raise and yet he has $3123 less in cash than he had the year before.

The numbers: they are simple, but to Sneezy, they don't add up.

It Makes Me Wonder -- Ramblings on our Financial Illiteracy

Were we better off in the years before television? How about cable TV? Do you wonder where I'm going with this? I do as well. But, sometimes that's the beauty and the beast of blogging. You just start your nimble little fingers pecking away at the keyboard and something comes out. Some days, your readers like it, some days they don't. And, some days, they ignore you entirely.

But, back to my original premise. I am not familiar with those days, but I understand that back in the days before the boob tube (which doesn't have tubes anymore), reporters on the radio and in the print media for that matter usually knew what they were talking about, or at least did the research to try to learn. You didn't get your job there because you had a pretty face. Nobody saw your face. You didn't get your job there because you wore short skirts or had sexy stubble on your face. Nobody saw those things either.

But today, it doesn't seem to matter what you know. And, it doesn't seem to matter if you do your research. If you have a TV voice and a TV face and fit the profile (demographic, appearance, political leanings) that your potential TV employer is looking for, you can be an anchor. And, if you seem somewhat intelligent among those who may not, you might even get to ask questions of potential candidates at a Presidential debate.

Last night, there were nine individuals who put themselves forth as Republicans, all of whom say that they want to become President of the United States on January 20, 2013. It looks like there is roughly a 50/50 chance that someone from that group of nine will succeed in that goal (if you think the polls are way off and that either President Obama will easily get re-elected or will easily be defeated, don't argue with me here). Last night, many of them got asked questions about Social Security by one of the chosen panelists.

I don't know who underwhelms me more -- the pretty faces who get to ask the questions or the politicians who attempt to answer them. Yes, there are candidates who appear to financially literate -- financially savvy -- but the bulk of them spew forth as if they understand things like present values and actuarial projections

So, how does this all relate to anything (unless I am changing this to a political or news media blog)? Well, people that Americans look to for information and leadership are not financially literate. If you're getting your information from these people, or scarier still, being led by these people, you are more likely than not to turn out financially illiterate as well. And, that makes me wonder (apologies to Led Zeppelin if you think I am plagiarizing from "Stairway to Heaven") ... It makes me wonder if our massive financial ignorance will bury us in the current financial downturn (or whatever you choose to call it) forever.

Let's consider some of the things that we know if we listen to the talking heads or the politicians:

• The Patient Protection and Affordable Care Act (health care reform) will save the country money. Wait a second. If the CBO projections are correct, health care reform will save the country money in total over its first 10 years. By year 11, that savings is fairly likely to turn into a cost. But the CBO follows its rules (as it should) and politicians spew forth.
• The Social Security Trust Fund will go broke by 2040. Yes, there are forecasts that show this to be the case, but there are all forecasts that show it to go broke sooner and those that say it will be later. These are long-range forecasts with many variables. If employment picks up, more money will be paid into the system, presumably by younger workers, and more older workers may postpone drawing their benefits. If it doesn't, then the Social Security system may be in bigger trouble.
• Defined benefit plans are one of the primary reasons that we are in financial turmoil as they are far more expensive than 401(k) plans, but the actuaries hid that from us (yes, I heard that [paraphrased] on TV). Simplifying somewhat, a 3% of pay cash balance plan (adjusted for things like turnover) is not materially more or less expensive than, for example, a 3% of pay non-elective contribution to a 401(k) plan. A traditional final average pay defined benefit plan can be designed to have the same costs as either one of them. The fact is that the cost of a defined benefit plan may have more volatility and that there will be times when defined benefit plans will, generally speaking, be underfunded (or overfunded), but if Congress had better understood defined benefit plan funding when they enacted some of their silly laws, neither the volatility nor the underfunding would be as much of a problem.
• Don't check your 401(k) account balance today, the markets are down too much. If you're checking your 401(k) account balance every day, you need to find something else to do with your time. A 401(k) plan is a retirement plan. The idea is to build up your account over time, more rapidly when investments are performing well, and conversely, at a slower pace when your investments are not performing as well. The markets will go up and they will go down. Deal with it.

I could go on. You could go on. But, I had my say, and now I feel much better (I usually feel better after blogging; it's my drug of choice.). What's your say?