Although I am primarily concerned in my job with retirement, it’s been difficult to ignore the contentious debate going on about health care. Since health care is one of those issues that retirees (regretfully) will have to deal with, I thought I’d take a moment to tell you what I see, as an interested observer.
First of all, I find it unlikely that nothing will happen. It seems like everyone agrees that something needs to be done, even though not everyone is proposing the same solution.
As I follow the debates, I see two main issues:
(1) covering health care needs for everyone, or most everyone, and
(2) the cost of health care
While the two are necessarily linked, I see them as separate issues. For my part, I would have tackled the cost issue first, and then the coverage issue, but it seems that Congress has decided to link the two together, for better or worse. By the way, I don’t buy the talk of rationing care, and I don’t see that there will be “death panels”.
Within the coverage issue, I see some people making (what I consider to be deliberate) misrepresentations. To begin with, I do believe that everyone should have access to health care. However, being insured is a different concept than having access to health care.
The debate shouldn’t be whether 47 million people are uninsured; rather, it should be whether everyone has access to the care they need, when they need it.
Even those who talk about the insured make the mistake of throwing all insured into the same category. I can tell you that not all insurance is the same, and some policies aren’t much better than being uninsured.
Finally, and most importantly, a lot of what I read seems to say that the employer has some obligation to provide health insurance. I think nothing could be further from the truth. I look at my health insurance as a portion of my compensation.
My employer has group buying power, and so can get me a good deal on something I want. While I would be disappointed if that health insurance were dropped (and I would consider such a change to be a cut in my compensation), my employer has no more obligation to provide health insurance than it does to provide me with a car freshener.
The cost issue is one that I don’t think there are easy answers to. The politicians say they are targeting the unholy trinity of “waste, fraud, and abuse” in the system. I think I first heard those three items from Augustus Caesar, but I’d have to check my planner notes to be sure (I was doing it on papyrus back then).
If fraud, waste and abuse were really the solutions, why isn’t the government going after the perpetrators right now? No legislation is needed to crack down on fraud or abuse. Why the implication that fraud and abuse will only be acted upon if coverage is expanded?
There’s also talk that health care companies are getting excessive profits. My guess is that most companies are in business to make a profit (other than not-for-profits). When times are good, they make more profits. When, then, does a profit become excessive? And by the way, if you’re invested in one of these companies, as many of you are through whatever mutual funds you may hold, do you think that your earnings have been excessive on your account?
The two areas I see as really having the potential for cost savings are ineffective care and inefficient care. We need to change our tort system. We need to make preventative care more accessible (not – ugh! – wellness care, which costs more than it saves). We need to allow and encourage nurses and nurse practitioners to treat minor ailments.
But, let’s face it---this is going to cost us, as a country, more. There’s no way that giving more and better health care to more people isn’t going to cost something.
Right now, the bill looks like it will run at least $300 per year per person. So in some form or fashion, it’s going to cost the average family of four approximately $1,200 a year to expand health care. That’ll be paid through higher taxes, higher costs, foregone compensation, or some other method. For those of us who have been blessed with above average income, the cost will be higher, perhaps substantially.
So, how does this all tie back to retirement? Well, for one thing, those of us who continue to age (and not many of us have found a way to stop the process) will need more and more health care, which will cost more and more. Medicare is going to be in crisis here shortly, and that could make benefits less robust.
Some of the current talk is about cutting back on the Medicare Advantage programs, which will mean more out-of-pocket expense. Payouts for medical procedures may be cut back, and doctors talk about not taking Medicare patients.
All in all, my guess is that once I get to retirement, Medicare will cover less, so I will pay more, and the amount of time I spend navigating the health care maze will increase substantially.
Not necessarily a rosy picture, but I think it’s realistic.
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I had a client one time say that the process of changing from one 401(k) provider to another was more painful than birth. Since this client happened to be a male, I wonder how he could make that comparison, but that’s beside the point. The point is that changing your provider can be a long, cumbersome process—more so than most people realize.
One reason for this is that you have two business competitors involved in making a conversion work. The provider that is losing a 401(k) plan is not that anxious to let go of the assets. In addition, that provider has just lost a client, and the priority given to that lost client drops precipitously right after the client tells the provider they are leaving. It is not at all uncommon for the former provider to say that a conversion date is some weeks or months in the future, which can translate as “when I get around to it.” This can be exacerbated if the former provider has products that take some time to be liquidated (note here to plan sponsors: you should know whether there are restrictions on transferring your plan assets elsewhere; if you don’t know, you should find out).
Another item that delays conversions and increases paperwork is the Sarbanes-Oxley (SOX) law that was passed in the wake of the Enron debacle. SOX says that a participant has to get a 30-day advance warning if he’ll be unable to access his account for more than three days. And that notice has to say when that blackout period will start, and when it will end. That has the effect of lengthening the blackout, because the providers on both ends want to give themselves leeway to meet the future dates that the participants have to be given.
The conversion process itself takes some time. All assets at the former provider have to be liquidated and transferred to the new provider. That seems simple enough until you think about trailing dividends, uncashed checks, forfeiture accounts, receivables and payables of one sort or another, outstanding loans and loan payments, assets that aren’t readily tradable and so on. The former provider has to give the new provider an accounting of all of these things, and any and all differences have to be reconciled before the participants’ accounts can be put in place (but see the paragraph above about the former provider’s motivation to be cooperative and timely).
In addition, the former provider must give enough data to the new provider to establish the accounts properly, such as loan amortization schedules and total deferrals to date. And the new provider needs to receive previous documents, government filings, test results, etc. Then both the client and the participants have to be educated on how all of this is going to work once the whole thing gets started.
If all of this seems like a lot of work, you are right. In most shops, the cost of bringing on a client is so high that it takes 3-5 years before a provider starts to realize a net profit on a client. If it seems like it would take a while to make the conversion, you are also right. A 60-day timetable can be considered aggressive, given all of these hoops that have to be jumped through. A great irony here is that it can sour a relationship with a new provider when the process does take this long, even when the new provider does everything right.
Update on a previous blog: Last December, I wrote that I expected some type of automatic retirement savings to be enacted this year, possibly with a 2011 or 2012 effective date. That’s still being considered by Congress, but I think the likelihood of it passing this year is becoming more remote as the healthcare debate drags on. Also, while the enactment is estimated to increase retirement savings by $100 billion per year, that would also translate into foregone tax revenue of $20 billion per year, which the feds can ill-afford to let go of anytime soon.
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For those of you who aren’t familiar with the concept of socially responsible investing (SRI), it means aiming your investment dollars at what are considered to be investments which promote some good cause, and therein lies part of the rub: what’s a good cause?
Some people want to avoid investments in countries with bad human rights records—places like the Sudan or Myanmar. So political considerations may make for socially responsible investing. Others may want to avoid manufacturers of certain products, like alcohol or cigarettes. Still others may want funds that only invest in green technologies, or Christian companies or companies that make third world micro-loans. Back in the mid-1990s, Jesse Jackson wanted Congress to require that all retirement plans be required to invest 5% of their assets in projects that would benefit minority-owned businesses. As all of this suggests, the first problem in addressing SRI is defining what exactly is meant. My guess is that not everyone who is asking for that type of investment is meaning the same thing.
A second, somewhat related problem is that there just aren’t that many funds out there that are SRI funds. I took a quick look at the site SocialFunds.com, and found fewer than 200 that meet their various criteria, and many of those were run by companies that I had never heard of before. Also, that quick look shows funds with higher expense ratios, a not-surprising situation when you consider the extra screening required.
The third issue is that SRI funds generally don’t perform as well as other similarly situated funds. Why? Well, the higher expense ratios may be one reason. A more pervasive reason is that the funds have to choose their investments from a smaller potential pool. Think of it this way. I’m a fund manager, and I go through all of the normal screens to pick my investments. If I’m an SRI manager, I then have to go through another step, and screen out investments that don’t meet my fund’s criteria. It doesn’t matter whether those investments are great performers, I have to screen them out. So, I have fewer funds to pick from. Fewer choices mean lower returns and more risk.
So am I saying that SRI is a bad way to go? No, not exactly, but I am saying it will usually result in a lesser return. If you’re willing to sacrifice some return for something you see as a greater good, that’s certainly an option available to you.
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Don’t you hate it when you ask a question, and the response is: “That’s not our policy?” Me, too. Unfortunately, that answer, in various forms, gets used a lot in service industries. In retirement plans, that can be the right answer, but more often than not, that’s a (bad) substitute for saying “There’s some reason for this, but I don’t know what it is.”
So, here are some reasons why a retirement plan administrator might say you can’t do what you want, or you might have to do something that you’d rather not:
A good 401(k) plan administrator not only understands each of these factors, he also knows how they interact with each other. For example, something may be technically allowable under the Internal Revenue Code, but can’t be done on the administrator’s computer system, and would require a lot of resources to be done by hand. As a result, the administrator says it won’t perform the requested function, or uses the shorthand “that’s not our policy.” A really good administrator can explain why it won’t do the function. A really, really good one can explain it in terms that make sense to the average client.
When I am asked a question about one of our 401(k) plans, I go through a kind of analysis in my mind. First, I make sure I understand what the situation is with the employer or plan sponsor. I then consider the plan type and the document provisions. Systems and resources come next, and then I look at preferences and policies. I can then decide what options, if any, are available to give the client what it wants. By doing my analysis this way, I can do more than just say it’s not our policy; I can say why something can or can’t be done.
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I saw a “60 Minutes” program a couple of weeks ago. It purported to be about 401(k) plans, but it spent the first part of the program talking about people at a job fair. As far as I could tell, the only connection with those people at that job fair was that their 401(k) account balances had taken a hit, along with their job prospects. There was even one man who opened his 401(k) statement on the air, to show how much he lost. While this opening did not have the drama of Geraldo Rivera opening Al Capone’s vault, at least there was something inside. I have to say, though, that I don’t quite understand why someone going to a job fair would bring along an unopened 401(k) statement.
In any event, this gentleman, and then a lady, discussed the fall of their 401(k) balances regretfully, and even tearfully. Hopes and dreams they had for retiring had vanished. Instead of being a few years away from retiring, they faced the prospect of working for a significant number of years, and as their attendance at the job fair attested, they were having to find new jobs to continue to work.
Many people who received their statement for the 1st quarter of 2009 had disheartening news. For the first quarter, my favorite market gauge, the S&P 500, dropped from 903.25 to 797.87, more than a 10% dip. And that’s on top of the 40% drop in that gauge since its October, 2007 high. Everyone’s wondering when it will end.
I think it already has ended, but I can’t sit here and say I know that for certain. There are quite a few people out there who think this a bear market rally, or a suckers’ rally. Some pundits say that there’s another drop coming, to as low as a 600 S&P.
It’s hard to say why I feel the bottom has been reached. Part of the reason is that the market has trended up now for the past two months. More than that, if I look at an historical chart for the market, I see spikes in 2000 and 2007, but if I smooth out those spikes, I get a line above where the market is today. As I read the various reports on the economic tea leaves, I see good news and bad news, but the good seems to be outweighing the bad. Reading the opinions of the various bulls and bears, I read comments on both sides, but more positives (albeit cautious positives) than negatives. Looking at the funds we offer in our 401(k) plan, I see that 15 out of 19 are positive to date in 2009.
So, what’ll you see if you open a statement for the year, or look at your account balances online? When I looked at mine, I had a net gain. Not a big gain, mind you, but still a gain. I haven’t returned to the high points of 2007, but I’m moving forward. It’s like I’ve ridden out the hurricane, and my ears are still ringing from the howling wind, but it’s time to go outside, assess the damage and start the cleanup, because the storm has passed.
]]>Do We Really Want to Reinforce Poor Planning Behaviors?
I was disappointed, but not really surprised, to see a columnist’s comments about Social Security.
Charles Krauthammer is a weekly columnist for The Washington Post. I recently read an opinion piece by him titled, “Obama: The Grand Strategy,” in which he referred to the fixing of Social Security as “relatively easy.”
Krauthammer says the answer will be “…some combination of means testing for richer people, increasing the retirement age, and a technical change in the inflation measure (indexing benefits to prices instead of wages). The proposal is brought to Congress for a no-amendment up-or-down vote. Done.”
Now, I’m OK with increasing the retirement age; I actually recommended it in a previous HRTools.com Insight titled, “Dear Mr. President: Ideas for Fixing Retirement Planning Problems.”
I’m also OK with changing the inflation index. I have a problem with the “means testing.” Here’s why.
“Means testing” means that a person’s overall wealth and/or income would be considered for the purposes of determining Social Security benefits. If a recipient’s wealth or income is above a certain level, the recipient’s benefits would be reduced or subject to a higher level of taxation. This is one of the principals behind all social welfare programs such as Medicaid or the Supplemental Nutrition Assistance Program (food stamps); i.e., the benefits, which certain individuals receive, are based on each individual’s eligibility needs for those benefits.
So, let me give you a hypothetical situation. My clone and I start working in the workforce at the same time, and we make the same salary all through our lives. We’ve paid into the Social Security system like good little boys for the past 35 years, and we’ve been promised we will receive a benefit when it’s our turn to retire. As things stand now, we’ll get the same benefit.
My clone, though, is something of a spendthrift. He spends every last dime he makes. He frequently takes the family to Walt Disney World, drives a new Lexus and eats at fancy restaurants. He hasn’t saved anything for his retirement. Meanwhile, I go to Galveston for my vacations, drive an older Honda and eat out at McDonald’s. My friends say I’m cheap, but I’ve saved for my retirement, and I hope it will be a secure one.
What will “means testing” do for me and my clone? My answer is: My clone will get more Social Security benefits than I will. Because I’ve been prudent and saved, I’m going to be eligible for less Social Security benefits in retirement. My clone, having spent every cent he made, will get a larger check as a result. At the risk of using an over-used word, this doesn’t seem ‘fair.’ This solution seems as though I will be punished for having saved, while the person who spent will be rewarded.
Think of what this solution will tell our children. It’s better to spend it all now, because saving only means that you’ll earn less in benefits down the road. Or, conversely, that it doesn’t matter if you spend it all today, because if you do, the government will boost you up to where you need to be. I don’t think this message reinforces how we want them to view their personal finance practices.
Yes, I realize that no one is going to get rich off of Social Security, and I’ll probably still have a better lifestyle than my clone. But, the question is, when do we stop subsidizing irresponsible behavior?
]]>I got a briefing the other day about what the Obama administration might do for retirement plans. Actually, it was just a meeting with some people who know more than I do; it just sounds cool to call it a briefing.
Possibly, you’ve been deafened by the silence concerning U.S. retirement plans because Obama has had a few other things on his plate. And, really, the news is that there’s very little news about retirement planning issues. It doesn’t seem to be much of a priority for the Obama administration.
Nevertheless, it seems likely that something will have to be done about retirement plans in the not-too-distant future. Because of the decline in the value of everyone’s investments, the defined benefit plan—the old-fashioned pension plan—is going to have its own financial crisis and may ultimately need its own bailout.
Here’s why: Defined benefit plans are a promise to pay a specific benefit at a specific point in time. Let’s say that an employer promises a pension of $500 per month to an employee when he or she turns age 65. An actuary could tell you that the cost of that pension would be around $75,000, meaning that when the employee turns 65, $75,000 needs to be set aside in a pension plan for him or her to get that benefit. So, let’s say the employee is 60 now and expecting that $500 to start in five years, as was promised.
And, let’s say that the employer has done a good job of building up the assets of the plan, at least up until now. If so, then the pension plan had, let’s say, $50,000 earmarked for the employee’s retirement before this market downturn. Now that $50,000 is worth maybe $30,000, but the employer is still committed to paying the employee the same $500, so the employer still has to have $75,000 in five years. This means that the employer’s payments to the plan are going to have to go up to almost four times what they were before the downturn. A show of virtual hands here: how many employers could afford to quadruple their retirement payments in this environment?
The “so-what” inference is: Employers aren’t going to have the assets to meet their commitments, so they’re going to be looking for help from someone. And lately that “someone” has turned out to be the federal government. What the employers are going to ask for, and what they’re going to get are: open questions. Most likely, the relief will take the form of a postponement of the day when pension obligations have to be fully funded.
This possibility is risky because it would mean that a pension would start before all the assets are in place. If they are funded later, you won’t know the difference. But if they don’t get funded, that could be a problem. Another possibility might be that the liabilities will get frozen as of today; so that $500 the employee was promised—if he or she worked until age 65—may only be $375 if it gets frozen today. A third possibility is that the Pension Benefit Guaranty Corporation (PBGC), which is the federal agency that protects pensions for many working Americans, will have to foot the bill for the deficit. Note: The PBGC is to pension plans what the Federal Deposit Insurance Corporation (FDIC) is to banks.
So now you might be asking, “What’s this got to do with me? I’ve got a 401(k) plan.”
The thing is this—the defined benefit mess will create urgency-for-actions in response to retirement plan issues; whereby changes to 401(k) plans will get swept in. They will figure they’re in there anyway, so why not just make whatever changes they were going to make anyhow?
And what changes might those be? I don’t think we know just yet. There was some talk about making automatic enrollment mandatory, but that option was pulled off of the table. It’s possible that there will be some tie between executive compensation and maintaining an “adequate” retirement plan (whatever that may mean).
I think there could be some legislation proposed that will require more detailed disclosure of the fees that are being paid by 401(k) plans. I am always scared that there will be some attempts to tax 401(k) plans earnings or balances as a way to raise revenue, and perhaps in order to help with the pension bailout (described above). Of course that will only be on the rich, won’t it?
]]>I know you are getting a lot of advice about how to run the country now, so I don’t feel like I am piling on to give you my piece about retirement plans.
Let me start by saying what you already know: You do have a retirement planning problem looming. All of us baby boomers are in our 50s and 60s, and many of us don’t yet have retirement figured out. Those who thought they were getting close have seen years’ worth of savings wiped away that they may or may not recoup. Others didn’t lose much, but only because they didn’t have much to lose. It seems inevitable (if somewhat lamentable) that the boomers will be looking to somebody to bail them out.
So, what are you going to do?
First thing is: You’re going to have to fix Social Security. We’ve been hand-wringing about it long enough. Now is the time for action: and that action is to raise the eligibility age for receiving full benefits to age 70. Oh, you can still allow people to retire at age 62 if they want, but with reduced benefits. You might even be able to nudge up what full benefits entail, and still come out ahead, if you delay payment of those benefits by a few years.
The thing is, as I’m sure your advisors could tell you, that Social Security was not intended as anything more than a safety net for old folks. But it has now become the first consideration for everyone’s retirement plan. So it doesn’t matter what it was intended to do, given that it’s now the only income many retirees have, and it will serve as the majority of their incomes for many others. By moving the retirement age up to age 70, this will help ensure there’s enough to pay the upcoming retirees without impoverishing other parts of the country. Will you catch some heat for doing this? Sure, but as good old Harry said, “If you can’t stand the heat, get out of the kitchen.”
The other thing that I hope you’ll address (and you said you would) is the lack of savings for retirement. Unfortunately, you’ve only got one tool in the toolkit for this, and that’s a tax break of some kind. But you know what? There are already tax breaks for savings. So, what else can you do? Well, one thing that I hope you will address is what incentives and myriad of hoops that the average employer has to jump through to get the tax breaks. The laws and regulations regarding retirement plans are so convoluted that it’s not worth the tax breaks to many employers, especially small employers. A specific proposal I could make is to do away with the concept of “top heaviness.” I know many employers who dipped their toe into a 401(k) plan only to pull it out when they found out what a top heavy 401(k) plan would cost.
And, yes, there are providers who are getting fat off of fees, while participants pay the price. But there are also participants paying the price for legitimate fees, which are too high because of the legal demands on retirement plans. Maybe someone in your administration ought to be looking at whether there are unnecessary regulations that run up the expense of running a retirement plan, without adding any real value to the participants’ accounts. I’ll be glad to give you suggestions; feel free to call me any time.
]]>I wouldn’t have thought the testimony of a single person could have caused this much hubbub. I must have been asked a dozen times over the past few weeks about it.
Someone testified to Congress that the tax deduction for 401(k) plans ought to be eliminated. And, on top of that, it was reported that the chairman of the committee was interested in the proposal.
I first heard about this when someone sent me an article from Workforce Management. The article referenced testimony from Teresa Ghilarducci, a professor of economics and the Director of the Schwartz Center for Economic Policy Analysis (SCEPA) at The New School for Social Research in New York City. Ghilarducci proposes eliminating the tax breaks associated with 401(k) plans. Instead, she proposes that everyone be required to contribute five percent of their income into a retirement account administered by the U.S. Social Security Administration, which would be invested in government bonds.
What set this story alight is that George Miller, Chairman of the Committee on House Education and Labor was said to be “interested in pursuing it,” and that he was “clearly against continuing tax breaks as they currently exist.”
So, should we all cash in our 401(k) accounts and run for cover? (Not that we’d get that much if we cash out now, but you know what I mean.)
No, don’t panic. This is one of several proposals made to help Americans out with their retirement savings plans. It just happened to be the most newsworthy in that it was fairly detailed, and pretty radically different from what we currently have.
Here’s a look at some proposals that range from the very modest to others that include these major variables: (1) will proposed savings be voluntary or mandatory; (2) will the savings vehicle of choice be something we already have such as 401(k) or IRA accounts, or something new such as Individual Contribution Accounts (a term you may start hearing about); and (3) what investment(s) will be dictated or allowed? Congressman Miller recently came out with a statement saying that he does not support abolishing 401(k) plans, or changing their tax status.
Don’t forget that there are still several proposals out there to overhaul what’s perceived by some as a failure of 401(k) plans. Lots of folks who thought they would have enough saved for retirement are now finding that it’s nowhere near enough. What frequently happens after events like this current market downturn is that a knee-jerk fix will be put into place, typically of a kind that will overcorrect for what were seen as the failings. A number of the proposals would mandate that all workers save at least at some level. Also, some proposals direct that the savings into investments managed by the government, either by the Social Security Administration or the agency that handles the government’s Thrift Savings Plan. A look at President-elect Obama’s plans show that he wants to give all employees access to IRAs through their employer plans, if they don’t already have access to some other type of retirement plan.
What can we read in all these tea leaves? I think it likely that the norm in retirement savings will become an automatic contribution, either to an IRA or to a 401(k), unless an employee elects not to make one. I think it probable that employers will have the duty to select investments for employees’ contributions, although it’s certainly possible that the investment choice will be dictated. I’d bet against the government being the recipient of the contributions, although I’m not ready to rule that out, especially for those who make default contributions. As to when this all might happen, I’d put it at the year 2011, maybe 2012. There’ll be other, more important fish to fry before then, unless the economy becomes brighter in the next few months and health-care reforms magically pass with short debate.
Change will come. But your 401(k) is safe for now.
]]>When talking about 401(k) plans today, it’s kind of hard not to get into a discussion about investments. Many people have seen the value of their accounts go down precipitously in the past 12 months. I’ve had one person tell me that all of his retirement planning had gone out the window with this recent market downturn — not only for him personally, but also for his plans to take care of his parents. My own 401(k) balance has lost about 38 percent of its value over the last year.
Of course there are the smug ones who have been in a fixed income, stable value or even-money-market funds over that time. They didn’t gain much over the past few years, but they didn’t lose anything recently, either.
I get asked by various people what they ought to do. I’ve even been asked to participate in surveys about what I’m doing with my account and what advice I am giving to others.
My best answer at this point is that I’m going to do…nothing. At least, I plan to do nothing different than what I have been doing. I’m 50ish (OK, 51). My wife is 40-something (don’t go there; it’s one thing for me to divulge my age, something else for me to rat on her). Her family tends to stick around a while, so to be conservative, I have to think in terms of providing for our next 50 years together. What’s happened over the past year equates to about two percent of that time line, so I tend to think of this as a bump in the road. It may be a big bump, but a bump nonetheless.
I’ve consistently allocated my investments with that long term in mind, so I don’t see a reason to do something different now. Hey, I wish — along with everyone else — that I had gone to cash at the top of the market last October. But, I didn’t, so here I am. All I can do is to make sure that what I am doing going forward is the right tactic.
The funds I invest in have good track records, and will probably produce consistent returns going forward. Is there a possibility that prices will go down again? Sure, but you’ll go nuts if you try to predict that. The good thing is there are lots of bargains out there. Stocks that people bought at $30 last October are now going for $20. It’s a buying opportunity, folks.
Fifty years ago, the Dow was around 500. It closed on November 7th at 8,944 points. Over that 50-year stretch, the Dow increased by 17.9 times, or just under 6 percent per year. So I think it is reasonable to expect that equity investments should continue to produce gains over the next 50 years, although there will be times when it goes down again. And, for my purposes, I am assuming a 6 percent return for this period of time forward.
]]>I don’t get it. That’s my reaction after reading yet another article about the dangers of taking a loan out of your 401(k) plan. The crux of all of these articles is that you’ll be worse off if you borrow from your 401(k) plan than if you don’t. But what a lot of articles miss is whether you’d be worse off if you borrow from someplace else.
Let’s assume I want to buy a car, and I’m going to have to borrow $25,000 to get it. According to Bankrate.com, interest on a 4-year note would be 6.51 percent. By contrast, many 401(k) plans have interest rates of prime plus 1 percent, which at this writing is 6 percent. So right away, I’m saving ½ percent per year, which makes economic sense to me. Over the life of the loan, I’d save $280, which isn’t a mint, but I’m not going to sneeze at it, either.
Where these articles seem to have a fit, though, is the opportunity cost of withdrawing assets via a loan. They point out that you’re better off leaving your assets invested and getting 7 percent than taking out a loan and getting 6 percent. Well, yeah, I agree that 7 percent is better than 6 percent - if you’re actually getting 7 percent - but how is that any different from putting your account into a fixed income investment rather than an equity investment. As I write this, there are many people who would have loved to have earned 6 percent interest over the past 12 months, and while that’s not always the case, almost every good portfolio model has some degree of fixed income investments. Besides, the difference in that 6 percent and the 7 percent over the term of the loan is pretty small.
Another aspect that these articles bemoan is that the loan taker may stop his contributions, and instead make loan payments. But that’s not an argument against borrowing against my 401(k) plan; it’s an argument against buying a car, period.
To me that’s equivalent to saying I can’t buy a car because I have to save for retirement. If I have only so many discretionary dollars, I may have to decide between a car payment and a 401(k) contribution. I’m not saying participants always make the right choice in this regard, but sometimes it’s a choice that has to be made.
The last bit of warning these articles give is that I would be paying myself back with after tax dollars, and that I’ll be taxed on them again when I withdraw them. Again, the right way to look at that is in comparison with a conventional loan. I would be paying that loan back with after tax dollars (and, as I say above, it would be a higher loan payment, so more after tax dollars would be used). And if I’ve left my 401(k) balanced undisturbed, I’ll be paying taxes on whatever dollars I withdraw, so I haven’t gained or lost any taxability there.
Now, don’t get me wrong, I’m not advocating anyone rush out and take a loan. I don’t particularly like debt, and I personally do what I can to not incur debt. And as an administrator, I’m only moderately in favor of the death penalty for whomever thought it was a good idea to let 401(k) plans have loans in the first place. But don’t let anyone scare you into thinking that it’s a bad economic decision to take out a loan from your plan.
]]>I just got done reading the Department of Labor’s (DOL) new proposed regulations of fee disclosures. If you haven’t read them, I think you should. After all, they’re only 103 pages long. I guess they’re a start at disclosure, but I can’t say that I think they’re a very good start.
The regulations require some annual disclosures and some quarterly disclosures: administrative expenses, individual expenses, and investment-related expenses.
Why do I think the DOL missed the boat?
First, because I don’t believe the annual notices are going to be read, except by very few participants. We already have to swamp them with notices and reports, and most participants don’t read them.
Yes, this may be seen as having a more direct impact than, say, a Summary Annual Report; but I’ll be surprised if it significantly modifies their behavior.
Second, if you tell the average participant that their Midcap growth fund has an expense ratio of 75 basis points, they have no idea whether that’s good, bad, or indifferent, because there is no basis for comparison (yes, I realize some participants know, but most don’t).
It can have the impact of driving participants to the lowest cost fund, without considering whether that fund is the right one for them. Also, the participant will have no idea whether the fund lineup is overall more expensive than it ought to be. If the least expensive fund has a 150 basis-point expense ratio, how does the participant know that all the funds are way too expensive?
There is another part of the regulations that I find laughable; and it takes up a large chunk of the regulations—the justification that this is good public policy. The regulations assert that the estimated cost of complying with this regulation over the next 10 years will be $759 million. The $759 million is assuming that an attorney will only need to spend 30 minutes to review and implement this regulation. I don’t know about you, but I don’t know many attorneys who will only charge me one hour of time to read 103 pages of regulations. They also estimate the cost of the disclosure will be 14 cents per person. I guess they forgot that the postage alone would be 42 cents.
I’m sure there are some who think that this is better than nothing. I’m saying, I don’t think so.
]]>“Fiduciary: of, relating to, or involving a confidence or trust: as a: held or founded in trust or confidence b: holding in trust c: depending on public confidence for value or currency…” Merriam-Webster’s Online Dictionary
The Fiduciary Rules!
My position requires me to act in the best interest of plan participants. I am one of the fiduciaries of our 401(k) plan. In my case, it was more of a choice than anything else. My position already requires me to act in the best interest of plan participants, and since that’s the primary responsibility of a fiduciary, I figured why not?
Some people, and even some companies, are scared to be a fiduciary. It has an ominous sound to it, especially when it’s paired with “responsibility.” The term “Fiduciary Responsibility” sounds like something that you’ll get in trouble for, eventually.
I know a great many service providers such as Third Party Administrators, brokers, attorneys, accountants, advisors, and even banks and trustees who go to great and elaborate lengths to avoid fiduciary roles. Much training of employees goes into showing them how to avoid becoming a fiduciary, for this reason: a fiduciary is someone named as a fiduciary and someone who also executes a fiduciary act.
Every 401(k) plan must have at least one-named fiduciary.
These individuals are responsible for ensuring that the plan is run the right way. There are many rules that say what the right way is, but they boil down to what I said earlier: The right way is running the plan in the best interest of the participants.
In addition to the named fiduciaries, some individuals or companies can become functional fiduciaries, meaning they perform functions limited solely to a fiduciary. Functional fiduciary roles can apply to anyone who (1) has discretionary control over plan assets; or who (2) renders investment advice for a fee.
For example, if you authorize paying Mr. Jones his account balance out of the plan, you are a fiduciary, whether you wanted to be or not. Likewise, if I receive $20 for telling you that fund XYZ is the right place for your money, then I become a fiduciary.
This functional definition causes much of the fiduciary fear. Service providers go to extremes to avoid meeting the fiduciary definition. They’ll tell you that a particular transaction looks good or bad, but they’ll also be quick to tell you that it’s your decision to make. Doing that takes them off the hook for making the decision.
Why are they scared to be a fiduciary?
Fiduciaries can get sued. A plan participant with a grievance about the plan, real or imagined, may look to sue everyone in sight, and fiduciaries have a target on their backs for a lawsuit. A service provider will claim that he didn’t make the decision, so he’s not responsible; and, “Therefore, ‘Your Honor,’ the case against my client should be dismissed.”
But, ask yourself this: If your provider will not stand beside you when there’s a problem, is that the provider you want?
I’m aware that I have a serious responsibility as a fiduciary. After all, keeping up with thousands of participants and over a billion bucks is a lot of responsibility. But I guess I look at it this way: If what I do everyday is in the best interest of participants, what have I got to be worried about?
]]>What Happens When Rules Are Abused?
I just got back from a trip to the West Coast. The purpose of the trip was to meet with client groups and to tell them about the retirement services we provide. It was not a big surprise to find out that they are very confused about 401(k) plans. They don’t understand why the plans have so many rules; why they have to be so complicated. I was relating this experience to a colleague, and her perspective struck me as being succinct: The rules are there because somebody abused the rules that were there before. That abuse caused Congress to enact laws to curb it, sometimes to the detriment of the plans as a whole.
Take the Top Heavy Tests. Please.
This is a test that compares the total account balances of key employees to the total of all account balances. If the key employees have more than 60 percent of the total, then the Employer is required to make a contribution to the non-keys, usually 3 percent of compensation. This law was written back in 1982, when defined benefit pension plans were the standard retirement plan, and Employers mostly paid for retirement benefits. The thinking of Congress at that time was: if you’re going to get a tax break for making contributions to a retirement plan, you have to make sure that the rank-and-file employees get a benefit, too. Conceptually, that makes some sense.
The Tax Reform Act
Then came 1986, and the Tax Reform Act (TRA--it started out as the Tax Simplification Act; it didn’t end up that way). The 401(k) plans were just starting to come into their own at that time. The TRA added tests to make sure that the contributions going into a 401(k) plan didn’t favor Highly Compensated Employees (HCEs). We now know those tests as the ADP and ACP tests. The rationale behind these tests was that Congress thought plans were being set up to let the HCEs defer taxes on large chunks of money and to receive matching contributions on those deferrals, without the average employee being given substantially the same opportunity to make salary deferrals and to receive matching contributions on those deferrals. (I should mention that, at this time, 401(k) plans were thought of as supplements to the defined benefit pension plans.) So now there were tests that had to be done, making sure that the percentage of pay deferred and matching contributions received by the HCEs was not too much greater than the percentage of pay deferred and matching contributions received by the non-HCEs.
But the Top Heavy test was still required, too. So a situation was created where, not only must contributions be tested for discrimination on the way in, but also the balances had to be tested for discrimination each year. In an instance where a plan sponsor has high turnover, the contributions going in each year may be just fine, but the plan becomes Top Heavy because the key employees stick around while the non-keys don’t. As you might imagine, this can be hard for an Employer to swallow: that his individual yearly contributions are fine, but the cumulative effect is not.
So, If I Were King, What Would I Recommend?
I’m glad you asked me that! I would eliminate the Top Heavy test for 401(k) plans. It’s anachronistic, and an employer is less likely to provide a retirement savings vehicle for his employees because of the potential impact of a test failure. In this day of poor savings rates, we don’t need a disincentive for employers to set up a 401(k) plan. We have the ADP and ACP tests for 401(k) plans. We don’t need a Top Heavy test on top of those tests.
Additional Online Resources and Information:
IRS Publication: Employee Benefit Plans, Explanation No. 7, Top-Heavy Requirements
United States Department of the Treasury Fact Sheets: History of the U.S. Tax System
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Investing 101
I volunteer with Junior Achievement. Once a week, I go into a classroom at Humble (Texas) High School, and talk to some seniors about business. I love doing this, because some of these kids are like sponges, soaking up perspectives on a world they barely know (there are also those who just want the change of pace). One of the activities I have with them is a game, where we see who can do the best at investing over the school term. There’s usually a prize of some kind to make things interesting.
Two Types of Investments
Before we play the game, though, I have to tell them what investing means. Not surprisingly, most of them don’t know much about it. What I tell them is that I know of only two types of investments:
The lending of money to someone else is what happens with a savings account, a certificate of deposit (CD), a money market fund, a treasury bill, bond, or note, a corporate bond; even some more exotic investments. If you lend money to someone, you expect it to be paid back, with some amount of interest that both you and the borrower agree to.
By contrast, when you buy a piece of something, you aren’t expecting to get paid back in the same sense. You expect that whatever you bought will:
If you buy stock in a company, you want it to:
(a) pay a dividend;
(b) go up in price; or
(c) both.
If you buy someone’s dollhouse store, you hope:
(a) it will make a profit;
(b) you’ll eventually be able to sell it for more than you paid for it; or
(c) both.
Which Road Do I Take?
So, when they’re deciding what to invest in, they have to decide whether they want to go the safe route, and earn interest; or, take the riskier route, and earn a piece of the action. Most of them go the ownership route, since it’s not their money, and it’s more fun to follow. But there are a few who want to go with something safe, but dull, and invest in a CD or something similar. I expect that these latter students will go that direction as they get older, too.
So far, every class where I’ve done this has made money over the term of the class. It will be interesting to see, in today’s market, whether that will hold true this year.
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Allow me a bit of nostalgia here…for the defined benefit (DB) plan. If you don’t know what a defined benefit plan is, that’s because it’s a dying breed; and, has been for a number of years. Fortune 500 companies may have a defined benefit plan, many times because a union insists on one. Some smaller companies have one, sometimes out of a genuine concern for their employees and, more often, because it can provide a large tax deduction.
Significantly fewer people today are covered by a defined benefit plan than when I started in this business 28 years ago. At that time, 90 percent of the work I did was on defined benefit plans. Now, they are a closed book to most benefits and HR professionals.
Defined Benefit Plan Problems
Part of the problem with DB plans is that they were hard to understand. In employee meetings, my spiel was something like, “If you work for (insert company name here) for the next 25 years, you’ll get a monthly pension of some percentage of your average compensation; payable for your lifetime or 10 years, whichever is longer. Meanwhile, your current vested accrued pension is $28.73, up from $20.21 last year, which you will get when you turn 65. Have a nice day.” The benefit was so theoretical to the average employees that they had very little appreciation of it, at least until they were getting close to retirement age.
Another part of the problem was that the employer costs for the DB plans were hard to understand, partly because of the complex funding rules. Most clients had a current benefit cost and a cost for past benefits. Those past benefits were amortized over 10 to 30 years, so the client had a range of contributions he could make. Very seldom could I tell the client that his contribution requirement was X; I had to say that it was anywhere between X and Y, unless he wanted to change funding methods, in which case the answer might be Z.
Along Came the 401(k) Plan
To me, though, what really killed the DB plan was the 401(k) plan. 401(k) plans were originally conceived as a supplement to DB plans, but now they are the only retirement plan for a majority of the population. By contrast to DB plans, a 401(k) plan is easy to explain to both employers and employees. It takes the responsibility for the employee’s retirement away from the employer, and puts it on the employee. It can be shut down more easily than a DB plan can be unwound. When a participant wants a distribution, all that needs to happen is an account balance review, and his payout will be determined. No mess, no fuss.
But there was a time when DB plans ruled. A retirement target was created, and that target had to be hit. No one would outlive his pension, because his pension was guaranteed for life. The employer, not the employee, paid for the benefit. A retirement plan was for retirement; it was not used merely as a savings account, or as collateral for a new car loan. And the work to value an account was done once a year, not every day.
Thanks for letting me indulge in a trip down memory lane.
]]>One of the questions that will come up in 401(k) plans, if your offers a Roth option is: Are you better off making Roth contributions to your 401(k) plan or the traditional pre-tax. My answer is: tell me what the tax rates will be like when you retire, and I’ll give you the right answer to your question. What’s that you say? You don’t know what the tax rates will be? Well, then, I can’t tell you which will be better for you.
While that exchange is somewhat facetious, it’s also true. For those of you who aren’t clear on what Roth contributions are, they are after-tax contributions to 401(k) plans. Traditional pre-tax contributions are not taxed when they go into a 401(k) plan. The contributions and their earnings are taxed when they are withdrawn. So, while pre-tax contributions let you avoid a tax bill today, you have a tax bill in the future. Roth contributions are taxed on the way in, but not taxed when withdrawn. In addition, provided certain conditions are met, the earnings are also not taxed when withdrawn. So you pay the taxes today, but not when you retire.
If you were to do some spread sheeting on which is better for you, and you assumed that your tax rate is the same today as it will be when you withdraw, then there is no advantage for pre-tax over Roth or Roth over pre-tax. It works out that you have exactly the same number of dollars to spend either way. The deciding factor then would be: when do you think tax rates on you would be higher? Some people are convinced that taxes will have to be raised in future years. If that turns out to be true, then you’re better off with Roth, because you’ll pay the taxes now, when rates are lower, and not when tax rates go up in the future. However, I would point out that, under current tax law, someone over age 65 gets an additional exemption. Also, if your overall income is less when you retire (which will be the case for most of us), your marginal tax rate will be lower than it is today. Again, that’s looking at current tax law.
I can’t tell you what the right decision for you is. You will find people adamantly in both camps, who will passionately explain why they are right in thinking the way they do. If you look into their argument, though, you’ll see that there’s an assumption about tax rates that has to be made to answer the question. My own personal decision has been to start making some Roth contributions, but most of my contributions are still pre-tax. You might say I’m hedging my bets in some way, but I’m still betting more on my tax rates being higher today than when I retire. Also, I’m taking the bird in the hand – a current assured tax reduction – instead of the birds in the bush – the possibility of higher rates.
So good luck with whatever your decision will be. The main thing is to save something, and whether it’s Roth or pre-tax, you’ll be much better off in retirement than if you dither and do nothing.
]]>There are a lot of people who wonder how much they need to save for retirement. Chances are, what you need to save is more than you’re saving right now.
Think of it this way. If you have $500,000 saved when you hit age 65 and start drawing it out, you’ll be able to take out about $25,000 per year, at most. Take out more, and you’re likely to be around longer than your savings. Now, $25,000 a year isn’t going to let you live in grand style, in fact, even with Social Security added in, you’re probably looking at a frugal lifestyle. Still, many people think of $500,000 as an unattainable goal.
One way to look at what you need to save is to simplify your thinking. Say you’re 25 years old, you want to retire at 65, and you have a life expectancy of 85. That means you want to work for the next 40 years, but have your income last for the next 60 years. The way you’d have to do that is to save 1/3 of your income for the first 40 years, so you’d have enough for the last 20. If you decide you’ll postpone retirement until 70, you’ll work 45 years, and still need your income to last 60 years, so you’d have to save ¼ of what you earn.
Now, these are simplified examples. They don’t take into account interest on what you save, or increases in your salary, but they also don’t take inflation into account either, and they assume you did the right thing back when you were 25 (don’t we all wish). So, even more complicated projections will show that saving 15% is the least anyone can save, starting at age 25, if you want a comfortable retirement. If you save less, you’ll have one of two options: learn to live on less income than you had before you retired, or retire (maybe a lot) later.
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