The Plight of Retirement And It's No-Mention Status in the Election

We have a Presidential election coming up. We have 34 US Senate seats that need to be filled this year and 435 seats in the House of Representatives. I've looked pretty closely. I've not see a single comment from an individual running for one of those offices that mentions retirement policy or retirement plans. That, while a majority of working Americans either worry daily about the prospects of retirement or would and should have that worry if they came out from under that rock they have hidden under.

There has been far more emphasis on other areas of workers' rewards packages and frankly, that emphasis has not had a major positive effect on the bulk of those American workers. Perhaps you have seen differently, but the three things that have gotten lots of focus ordered only by the way that I choose to type them have been:

• Health care (primarily the Affordable Care Act)
• The need (according to many to reduce executive compensation
• The hourly minimum wage

Let's assume for the moment that if you are reading this that you are over the age of 25 (if you're under 25 and you have an interest in what I write here, I expect that you will have a successful future) and that you have some useful skill set. If that's the case, then there is a good chance that you are employed, employable, and looking for work, not working by choice, or retired. 

If you are working and you fall into those categories, there is a very good chance that you have access to decent health care benefits and, in fact, you probably had them or would have had them had you been similarly situated, before the effective date of the Affordable Care Act. So, while the ACA may have made some changes to your health benefits, it's not likely that those differences were life-changing for you (yes, I understand that uncapping the lifetime maximum and allowing your kids up to age 26 on your policy could have had that big a difference for you).

Similarly, most of us are not executives and certainly not of the classification whose compensation draws the significant ire of others. As individuals, we might have opinions on levels of executive compensation or we might not, but most of us know that even reducing our CEO's pay by 75% would not change our compensation one iota. We are compensated roughly on our value in the marketplace. Our value does not change merely because our CEO takes a pay cut.

Finally, there is the hourly minimum wage. I could be wrong, but my observation is that there just aren't a whole lot of people earning less than $15 an hour (unless they are currently in school) who read this blog. So, for you, the hourly minimum wage probably doesn't make much of a personal difference (I understand that you may have very strong opinions on it, but those are from the standpoint of what's right and what's wrong).

Where is poor little retirement? Social Security gets debated. But, we all know that you just can't retire on Social Security. 

I'm not going to spout statistics here because I don't have them at my fingertips. But, my observation is that a generation ago, far more employees than not were covered by meaningful employer-provided defined benefit (DB) plans. And, among those who were not, likely the majority of the rest were in often generous money purchase or profit sharing plans. 401(k) plans were in their infancy. As I've written many times here, 401(k) plans were never intended to be a primary means of retirement savings. 

That was the way of the mid 70s through mid 80s. 

Today, as we know, more employees than not, have a 401(k) plan as their only employer-sponsored retirement plan. Many of them are not generous. Many are poorly invested. In a perfect world, the employees in many of those plans will find it difficult to retire with anywhere near the standards of living they are used to. 

It gets worse, of course. Many of us will have or have had work interruptions or, at the very least, periods where we need to reduce or even cease our 401(k) contributions.  

We have a crisis. 

There, I said it. I believe it. 

In fact, it affects and will affect more Americans more profoundly than most of the issues being hotly debated. It certainly affects us more than does knowledge about Hillary Clinton's emails or Donald Trump's tax returns.

Yet, the candidates remain silent.

So very sad.

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?

The Easy Benefits Answer May be Compliance

I ran into an interesting situation the other day. I can't disclose enough of the details for reasons of confidentiality to use that as a case study. The point of the exercise, though, was that a client was looking for a loophole to escape the claws of what it was told is a horrible provision of the Internal Revenue Code. After analysis, however, I was able to determine that the loophole, as they put it, just doesn't work for them.

There, was a better and simpler solution, though. Just follow the law (without regard to the loophole).

While I can't use this week's example, it harkens back to the late 80s and early 90s (yes, I was doing similar work even then). Readers in their 50s or older may recall that the first Tax Reform Act of 1986 (TRA86) regulations to come out were the proposed 401(l) regulations that graced the pages of the Federal Register in late 1988. Lawyers, consultants, and actuaries (me among them) raced to digest those regulations and to be the first to tell their clients and prospects how to comply.

I digress for a moment to explain why this could have been so important. 401(l) explained how to integrate certain qualified retirement plans with Social Security in order for those plans to be exempt from the general test for nondiscrimination under Code Section 401(a)(4). Prior to TRA86, permissible integration was determined under Revenue Ruling 71-446, and whether or not a group of plans was discriminatory in nature was determined under the comparability rules of Revenue Ruling 81-202. What was different, though, was that if you had an integrated plan and you couldn't prove that it was properly integrated per RR 71-446, you risked your qualified status. Under TRA86, proper integration was more of a convenience.

Returning to the main plot, we all rushed out to our clients and many with defined benefit (DB) plans redesigned them to be properly integrated making them safe harbor. Those clients then needed to deal with transition rules under Notice 88-131. Some with good memories will remember racking our brains over choices between Options II and III and Alternative II-D.

Other sponsors made a different decision. They chose to not redesign their plans. That meant that they had to comply with the general test for nondiscrimination.

Well, for most, that turned out not to be such a big deal. It meant that every year or two years or three years, they had to engage their actuary to perform a test that was usually pretty easy to pass. What they got in return was a lack of disruption. For them, the easiest answer was not to find a way out of testing, but simply to pass a test that they could easily pass.

Returning finally to my initial point from this post, the client in question was trying to get out of a rule that counsel had told them was pretty horrible. And, it's true, it can be a horrible rule. But, in this specific case, the compliance burden associated with this rule will be minimal.

And, that means that what is perhaps the optimal solution will be simple.

Sometimes, the right answer has nothing to do with loopholes. Sometimes, the easiest (and best) answer is compliance.

The Truth About Actuarial Valuations of Pension Plans

I've heard the same comments for years. I've heard that a company loves its actuary, but they can't give you one reason why. I've heard that actuarial work is a commodity and that everyone produces the same numbers, so you might as well go with the lowest bidder. There's more; there's lots more.

I'm here to tell you that it's all wrong and it's wrong now more than ever.

Let's revisit history a little bit. In the beginning (well, not quite the beginning), there was ERISA. And, Congress saw that it was good ... for a while.

ERISA brought us rules and choices. The rules said that plan sponsors had to fund the sum of the annual cost of benefits that were accruing (normal cost) plus a portion of the amount by which the plan was underfunded using some fairly complex formulas. But, those calculations were pretty malleable. In fact, there were many methods by which to calculate those numbers and if you couldn't find the methods to get you the answers you wanted, you could likely talk your actuary into selecting assumptions to get you to those numbers. That's the way the game was played from the mid-70s through the mid-80s.

Then, the rules began to change. Congress saw that corporate tax deductions for funding pensions were a significant drag on the federal budget. So, Congress sought to limit those deductions by bringing in multiple funding regimes. So, was passed the Pension Protection Act of 1987 as part of the Omnibus Budget Reconciliation Act of 1987. And, Congress saw that is was good ... for a while.

Multiple funding regimes theoretically brought multiple choices, but with the 90s came the era of full funding. With the use of high discount rates tied to assumed rates of returns on plan assets, those assets exceeded the calculated liabilities of the plan. More plans than not had no required contributions. Pensions were cheap.

And, then came the perfect storm. Interest rates fell, asset values fell, and Congress had to do something. In 2006, Congress passed another Pension Protection Act (PPA). And, Congress saw that it was good.

But, there was something different about PPA. It severely limited flexibility in calculating the actuarial liabilities of a pension plan. In fact, with very limited exceptions, without any knowledge of the actuarial assumptions being selected, another actuary could fairly well reproduce that calculation of actuarial liabilities (at least within in a few percent).

But, what we have now is a tangled web. There are so many liabilities and percentages. Every single one of them affects the cost of your plan. There is the funding target, the plan termination liability, the liability for purposes of calculating PBGC premiums. There's the FTAP, the AFTAP, and various other funding percentages.

While each individual calculation is simple, getting to the correct answer is not.

And, that's why your choice of actuary for your plan is actually far more important today than it used to be.

Suppose I told you that your actuary's lack of attention to your plan as compared to the rules was costing you more money annually than you pay in actuarial fees.

Suppose I told you that your actuary's not focusing on your business's cash flow needs was forcing you to borrow unnecessarily.

Suppose I told you that that renegotiation of a loan covenant that you just went through because your pension plan had too low a funded percentage could have been avoided.

The scary thing is that I have told companies all of those things. We're in an era now where calculation is easy, but strategy is difficult. In fact, more plans than not are using a suboptimal strategy. Don't you need to know if you are spending more money than you need to or if you are spending it inefficiently?

Multiemployer Law Fails to Work for the Plan it was Most Likely Developed For

In mid-2014, Congress enacted and the President signed into law the Multiemployer Pension Reform Act (MPRA) sometimes known as the Kline-Miller Act (for its original sponsors). MPRA was unique in modern political circles as it was sponsored by John Kline, a Republican from Minnesota and George Miller, a Democrat from California. It was also unique in that it had support from unions, from companies that employ union workers, from affected government agencies and from industry groups specializing in multiemployer plans.

All that makes it sound like a law that was practically perfect.

Some background for those who don't spend their days in the multiemployer plan world is useful. Generally, multiemployer plans exist in industries where an individual working in that industry may provide services to many different employers. In the Teamsters Unions (primarily truck drivers), for example, drivers may drive on behalf of many different employers. Each employer agrees to contribute an amount to the plan based on the amount of service provided to it by each worker under the agreement. So, for example, in the case of a Teamsters Union, contributions could be set at some number of dollars per thousand miles driven. Retirement benefits are set based on the levels that the trust can support.

Benefits under multiemployer plans are insured (to some extent) by the Pension Benefit Guaranty Corporation (PBGC). One of the reasons for the passage of MPRA was to protect the PBGC. This was to be accomplished by allowing plans that met a set of requirements (more later) to reduce benefits that had already accrued. As many of the industries often covered by multiemployer plans dwindle, the plans themselves are unable to support the levels of benefits that had been promised. There are just not enough dollars coming into the plans.

Based on data published initially by the Center for Retirement Research at Boston College, the single plan that was viewed as potentially most problematic was the Central States, Southeast, and Southwest Areas Pension Plan. With more than 400,000 member, a funded ratio just barely above 50%, and nearly 5 times as many inactives as actives (all as of 2012), the plan was estimated to become insolvent in 12 years. Many plans were projected to become insolvent sooner, but not represented nearly the liability of the Central States Plan.

As MPRA should have, it placed a strict set of conditions (see Code Section 432(e)(9)) on such suspensions. Cutting back retirement benefits had essentially never been permitted in an ERISA plan. Such a cutback needed to be in everyone's best interests.

The process for determining that was generally to be that the Trustees of a Plan would apply to the Treasury Department for such a suspension (the technical term for such a reduction). The application would need to demonstrate that the suspension met all of the conditions referenced above.

In the case of the Central States application, Special Master Ken Feinberg determined that some of those conditions were not met.

Specifically,

• The suspension must be reasonably estimated to avoid insolvency
• In making its projections, the Trustees or the outside consultants used by the Trustees assumed a rate of return on plan assets that for every asset class in the plan exceeded the 75th percentile (according to survey data) for that class
• The entry age for new participants under the plan was assumed to be 32. While data shows that 32 is the average age, that is misleading because a group of new entrants at age 32 would have no new retirees in the next 20 years. On the other hand, a group with average age 32, including some who are much older, would have new retirees representing cash outflow from the plan far sooner than that.
• The suspension of benefits must be equitably distributed meaning that a particular class of participants is not adversely affected more than other classes
• The Trustees sought to make use of participants who are or were UPS employees under the plan. UPS had completely withdrawn from the plan and made withdrawal liability payments under the plan. In doing so, UPS had fulfilled its obligations with respect to the plan.
• But, UPS made those participants whole under a different plan. In its application, the Trustees considered only the portion of UPS benefits attributable to the make-whole agreement. This was judged not to be an equitable distribution.
• Upon application for suspension of benefits, notices must be distributed to participants explaining the suspension and the reasons for it
• The notices must be understandable by the typical participant, but in fact contained lots of technical jargon.
• In the notice's worst blemish, it contains a 98-word sentence with 4 technical terms not defined anywhere in the notice.

For all these reasons, the application was denied.

What does this do?

It leaves the Central States Plan in a position where it is likely within roughly 7 or 8 years of becoming insolvent. This means that the PBGC will become responsible for an extremely large liability for which its multiemployer fund does not have sufficient assets.

Who wins? Nobody.

Who loses? The PBGC, the plan participants, and the multiemployer system.

We might as well say that Americans are the losers.

IRS Withdraws Troubling Provision of Proposed Nondiscrimination Regulations

Yesterday, the IRS released Announcement 2016-16 withdrawing parts of the nondiscrimination regulations it proposed at the end of January. Those proposed regulations had troubled many in the defined benefit industry since their proposal for a number of reasons (more below). From the standpoint of the IRS, the troubling part of the proposal addressed some serious abuses by practitioners and the sponsors they consult to. From the standpoint of practitioners, the proposed regulations took an objective test that has been around for quite a while and essentially changed the rules of the game.

I'm going to have to get a little bit technical here before I bring you back to reality. What the proposed regulations would have done was to make retirement plans with multiple formulas show that each formula applied to reasonable business classifications of employees or to pass a more difficult test.

Under regulations that were finalized in 1993 and then amended for cross-tested plans in the late 90s, a rate group in the testing population must have a coverage ratio at least equal to either

• 70% if the plan uses the Ratio Percentage Test to pass minimum coverage tests or
• The midpoint of the safe harbor and unsafe harbor (the midpoint is typically in the 25% to 40% range, but is determined through a somewhat convoluted formula) if the plan uses the Average Benefit Test to satisfy minimum coverage

It is far easier for a rate group to satisfy a lower minimum coverage ratio than a higher one. And, many plans had been designed around satisfying the lower threshold. While the preamble to the proposed regulation said that it was targeting QSERPs, practitioners found that they also were potentially problematic for many plans of small businesses and plans of professional service firms. 

Why would this be troubling? Certainly, among larger corporations, the prevalence of ongoing defined benefit plans has dropped precipitously, but many small businesses and professional service firms have adopted new defined benefit plans (DB) over the last 15 years or so and many of these plans would have found it more difficult or perhaps impossible to pass these proposed rules.

This doesn't mean that DB plans of this sort are out of the woods yet, so to speak. Clearly, the current Treasury Department views that plans of this sort may be abusive in their application of the nondiscrimination regulations, so we could see another effort from the IRS to make the regulations a bit less QSERP-friendly. 

In the meantime, there are some great DB designs that exist for companies that wish to provide meaningful retirement benefits to their rank and file employees. You can learn more about them here.

The Quandaries of Being A Retirement Plan Fiduciary

Last week, the Department of Labor issued its final rule on what it means to be a fiduciary and on conflicts of interest. Virtually everyone in the retirement plan industry has been scurrying about to determine what the effect of the rule is. Some, including the US Chamber of Commerce, say it will lead to unnecessary litigation. Others say it will drive unknowledgeable advisers out of the retirement plan business.

If you're interested in the details of that regulation, every large consulting firm, law firm, and recordkeeper either has or will be publishing their take on it. Here, however, I want to address a different issue.

If you sit on the committee that oversees a retirement plan whether its called the Benefits Committee, the Investment Committee, or the Committee for All Things Good Not Evil, by virtue of that role, it is probable that you are a fiduciary. That means that both individually and as a member of that committee, when making decisions related to the plan (not your own account in the plan, but the plan generally), you have a requirement to act in a fiduciary manner and in the best interest of plan participants.

That's not a low bar.

Instead of bringing up situations that arise from the new final regulations (the other articles will present you with all of those that you need), let's instead consider an age old problem. Suppose your company sponsors a defined benefit plan and you are on the committee that oversees the plan. Let's complicate the situation a bit by adding in the following fact pattern:

• The plan is covered by the PBGC (Title IV of ERISA)
• The plan is frozen and the committee's minutes show that the intent of the committee is to terminate the plan whenever it becomes well enough funded
• Your company is subject to US GAAP; in other words, you account for the plan under ASC 715 (previously FAS 87).
• Your own personal incentive compensation is affected by corporate financial performance measured under US GAAP
• Over time, you have received a material amount of equity compensation from your employer meaning that you now hold a combination of shares of stock, stock options, and restricted stock in your employer

Your actuary comes to a meeting with your committee and informs you that you have three options related to a funding strategy:

• Option #1 will keep the ASC 715 pension expense down and will not result in a settlement (that would be a loss currently), but will result in the plan being less well funded
• Option #2 will produce a settlement loss, but will get the plan closer to termination and leave it currently better funded for remaining plan participants
• Option #3 will reduce ASC 715 pension expense and get the plan better funded and therefore closer to termination, but will have a material effect on the corporate balance sheet and could cause the company to violate certain loan covenants

You do have a quandary, don't you? Only Option #1 will help you to maximize your incentive pay. In my personal experience, in days gone by, for that particular reason, Option #1 would have gotten some votes. If you vote for Option #1, are you fulfilling your responsibilities as a fiduciary?

I'm not an attorney, so I'm not going to answer that question, but I'm sure you can find many who would be happy to weigh in.

Option #2 looks like it could be better for plan participants. Of course, that depends a little bit on what better means in this context. But, if the committee goes with Option #2, you know that your incentive payout could be smaller. If you vote against Option #2 (another question for the attorneys), are you fulfilling your fiduciary requirements?

And, then there's Option #3. How far do you have to go to fulfill your fiduciary requirements? Do you have to make decisions that are clearly not in the best interest of the company, but that may be in the best interests of plan participants? 

It's tricky, isn't it?

Now, let's consider a different situation that may not affect your personal compensation. Using Strategy #1, your company will pay PBGC premiums equal to about 10% of its free cash flow. Using Strategy #2, those same premiums will be reduced to about 3% of free cash flow. But, your actuary isn't familiar with Strategy #2. And, you do have a really good relationship with him. But, the people who brought you Strategy #2 say you can only implement it by using them.

What should you do? What must you do?