Investing for 401(k) accumulation not the same as investing for lifetime income

By Jerry Kalish on Posted in 401(k) Plans, Annuities, Individual Retirement Accounts

While most investors these days are focusing on risk in terms of the market and its effect on their account balances, Tim Burns in his blog, Fiduciary Investor, says that they should pay attention to a larger risk. It’s longevity risk, or the risk of a retiree outliving his or her assets. Mr. Burns, in his post, Longevity Securitization, says that
 

The adoption rate of retirement annuities will however, be influenced by; investor perception, pricing, insurance industry risk retention models and the state of the structured investment markets.

Of all the factors that Mr. Burns mentions, investor perception will be the most difficult one with which to deal for two reasons.

First, most investors don’t even think there is a longevity risk. According to a recent Fidelity Research Institute study, Structuring Income for Retirement: Addressing America’s Emerging Retirement Income "Gap", retirees and pre-retirees are signicantly underestimating how long they need to make their retirement savings last.

Second, there is the annuity puzzle, the term given by the financial service industry to investor aversion to annuities. Some in the industry believe people say "no" to annuities because of: 

  •  A desire to leave a legacy
  • The complexity of annuities
  • A lack of financial literacy
  • An aversion to perceived loss
  • A desire to maintain control

The need for annuities is certainly there, but it remains to be seen how well the financial service industry will deal with both the logic and the emotion of the matter.
 

 

Don’t forget about Roth 401(k)

By Jerry Kalish on Posted in 401(k) Plans, Individual Retirement Accounts

Wealth manager, Russ Bailyn, in his Financial Planning Blog asks employers to consider the benefits of a Roth 401(k). Russ looks at it from the standpoint of the employee. Ours is with the employer, and unfortunately, it’s been slow  going with plan sponsors adding a Roth provision to their 401(k) plans available since 2006.

The big reason, we think, for employers to add Roth 401(k) is simply to allow employees to diversify. Just like allowing them to diversify their investments, a Roth 401(k) provides participants with an opportunity to diversify their future tax burden. Here is a link to our December 2006 Client Briefing, Roth 401(k): Giving Employees A Choice (PDF) that has FAQs on Roth.

And take a moment and check our Russ’ recent book, Navigating the Financial Blogosphere: How to Benefit from Free Information on the Internet, available at a virtual bookstore near you. (Full disclosure: we’re mentioned in the book but read the excellent reviews from others on Amazon).

“Just the facts” used to determine independent contractor or employee

By Jerry Kalish on Posted in 401(k) Plans, Cash Balance Plans, Defined Benefit Pension Plans, Employee Stock Ownership Plans

That’s Jack Webb who played Sergeant Joe Friday of the LAPD, arguably the most popular police character in television history in the 1951-1959 series Dragnet. (The 1987 movie spoof of Dragnet in which Dan Aykroyd played the Joe Friday character didn’t do the original justice). Friday’s catch phrase used in his investigations, "Just the facts, ma’am," remains indelibly etched in the minds of television fans.

It’s also the basis of determining whether a worker is properly classified as either an independent contractor or an employee. It’s a topic I’ve written about before in my posts, Who’s your employee: inquiring minds and the IRS want to know in 2006 and The great debate: employee vs. independent contractor in 2007. And it’s an issue that’s just always there.

Brian Hall in his firm’s (Porter Wright Morris & Arthur) blog, Employer Law Report, warns us about The Hidden Costs of "Independent Contractors". Brian discusses a recent case in which the court found that the workers were employees and not independent contractors. The court’s decision was based on "just the facts".

The financial implications of such misclassification can be enormous. Penalties and interest involving payroll taxes can pile up if someone is incorrectly treated as an independent contractor. And in the case of a retirement plan, the employer would have to make up the benefits the individual would have received.

It’s an issue we are particularly sensitive to with our clients at this time of year as we start to receive employee census data for 401(k) discrimination testing. One of the questions we ask is "Do you have any independent contractors?" A "yes" response initiates a discussion that the employer have a process in place that the independent contractor classification will hold up in the event of an audit.

401(k) loan? Just stop by the 401(k) ATM

By Jerry Kalish on Posted in 401(k) Plans

I’ve written several articles about 401(k) loans in the past pointing out the negatives, and at one point I asked the question, Are 401(k) accounts piggy banks?  Well, excuse me for being so retro, because now through the combination of modern technology and consumer marketing comes the 401(k) Debit Card. An article in TheStreet.com by way of InsuranceNewsNet tells us that a 401(k) plan participant who wants a loan can say Just Put It on My 401(k) Debit Card.

But before I could even post about this, Jeremy at his Generation X Finance blog wrote, The 401k Debit Card: Probably One of the Worst Ideas Ever. No generation gap between me and Jeremy on this one!

HT to Dave Baker at BenefitsLink.

If you can’t tell the rollover alternatives without a scorecard, then this may help

By Jerry Kalish on Posted in Individual Retirement Accounts, Pension Protection Act of 2006

Last year, I wrote that IRAs are becoming increasingly important, but rules can be confusing. And even more so when considering the rollover possibilities in moving benefits from one plan to another.  Portability of benefits between IRAs, SEPs, SIMPLE IRAs, Roth IRAs, 401(k) plans, profit sharing plans, defined benefit plans, 457 plans, and 403(b) plans can be wonderful thing – if you know the rules. So here’s a link to a "scorecard" in the form of a Portability Chart as of 2008 prepared by McKay Hochman. But if there every was a situation of "kids, don’t try this at home, this is it. Talk to a tax adviser first.

Scorecard icon design by Mike Rohde via Flicr.

In case you’re wondering exactly where the rubber meets the road when a retirement plan sponsor fails to monitor an investment provider…

By Jerry Kalish on Posted in 401(k) Plans

The other day I wrote about the duty of a fiduciary to monitor service providers in the context of 401(k) plan sponsors not being concerned about the consolidation service of providers. We also hear a lot about the duty of a fiduciary to not just select service providers prudently, but to also monitor them. And this advice is not just yadda yadda, because there is a real world aspect to it. And if you’re wondering exactly where the rubber does hit the road, here’s a real world situation to keep in mind.

An article in yesterday’s on-line edition of the North Hampton,  Massachusetts Eagle-Tribune about a businessman who must repay $100,000 reports that an owner of a local  architectural firm agreed to pay $100,000 to his profit-sharing plan as part of a settlement with the U.S. Department of Labor (DOL). The DOL accused the owner of failing to monitor a financial company that stole over $500,000 from the 11 participants in the profit sharing plan. The settlement with the DOL also included the owner paying an additional $10,000 fine and agreeing never to manage any other retirement plan himself.

And how exactly did the investment adviser now serving a 11-year prison sentence for the embezzlement of the funds get nabbed? The Eagle Tribune’s story said that according to a published report at the time the embezzlement scheme was only discovered after the adviser sent audiotape confessions to his wife, his mother, and the Exchange Commission, among others, before trying to kill himself.

Situations like this are fortunately rare, but stuff does happen. What should the business owner have done? I’m going to save that topic for another time in the very near future and discuss using procedural prudence in the selection and monitoring of retirement plan providers.

Picture above, in case you wondered exactly where the rubber meets the road…, by Fubuki via Flickr.

HT to Dave Baker at BenefitsLink for pointing me to this story.

 

Cash balance plans and retirement security

By Jerry Kalish on Posted in Cash Balance Plans, Defined Benefit Pension Plans, Pension Protection Act of 2006

While cash balance litigation continues to wind its way through the courts, the long-term implications of these types of retirement plans have been generally ignored. That is until now. Richard W. Johnson and Cori E. Uccello have just authored a study, "Cash Balance Plans: What Do They Mean for Retirement Security?", published by the Urban Institute,  a nonpartisan economic and social policy research organization. Here is the abstract of the report:

The conversion of traditional defined benefit plans to cash balance plans is among the most controversial aspects of pension policy today. Because the controversy has focused on the treatment of older workers, however, the debate has generally ignored the long–term implications for retirement security. This article examines the potential impact of cash balance plans on workerswho spend their entire careers in these plans, and focuses on the implications for mobile workers and for labor supply at older ages. The evidence suggests that cash balance plans can often provide more retirement security than traditional defined benefit plans or defined contribution plans.

Here is a link to the entire study (PDF).

401k(k) providers asking “should I stay or should I go?”

By Jerry Kalish on Posted in 401(k) Plans

See full-size image

No, this isn’t a post about the The Clash. It’s about the on-going consolidation in the retirement plan industry of 401(k) providers. According to the Spectrem Group, a consulting firm specializing in the affluent and retirement markets, more than two dozen 401(k) providers have either sold or outsourced the recordkeeping portion of their business in the last five years. It’s for reasons of lack of scale, e.g., Bank of California, or wanting to focus on their core business of investment management, e.g., Franklin Templeton.

Spectrem Group’s recent survey indicated that Provider Consolidation Not A Concern for retirement plan sponsors. How many retirement plan sponsors? A whopping 83% of the sponsors surveyed. That’s a lot of faith to have if you’re a fiduciary who has an obligation to select and monitor service providers. And 6% of the surveyed plan sponsors believe that provider consolidation will have a positive impact on them. And the other 94%?

Picture above, SHOULD I STAY OR SHOULD I GO, by U.Linder Photography.

“Subprime” is landslide winner of American Dialect Society’s 2007 Word of the Year award

By Jerry Kalish on Posted in 401(k) Plans, Cash Balance Plans, Defined Benefit Pension Plans, Individual Retirement Accounts

The Iowa caucus voting results are in, and so is the American Dialect Society’s 18th annual words of the year vote (PDF), and "subprime" won by a large margin. The vote, of course, reflects the  preoccupation of the press and public for the past year with a deepening mortgage crisis. The American Dialect Society (ADS) is an 118-year-old organization whose members include include linguists, lexicographers, etymologists, grammarians, historians, researchers, writers, authors, editors, professors, university students, and independent scholars.

According to the ADS, the vote is the longest-running such vote anywhere, the only one not tied to commercial interests, and the word-of-the-year event up to which all others lead. It is fully informed by the members’ expertise in the study of words, but it is far from a solemn occasion. 

Benjamin Zimmer writing about the award in his blog, Language Log, says that "Subprime"

has already been used in an extended sense to refer to the "subprime crisis" in the housing sector, and it could very well spawn other extensions as the crisis worsens. (One recent article claims that it is being used as a fanciful verb, as in "I subprimed my algebra test," but I haven’t come across any evidence of that in the wild.)

Well, Ben, I’ll let you know if I hear any of our clients’ younger employees say that "my 401(k) was subprimed". Hopefully, not.

Picture credit: Part of a series called BEST IN SHOW: The best and worst tradeshow displays at Calgary’s HomExpo 2007 by elboroom design via Flickr.

New Pension Protection Act rules can make two retirement plans better than one

By Jerry Kalish on Posted in 401(k) Plans, Cash Balance Plans, Defined Benefit Pension Plans, Pension Protection Act of 2006

Baseball fans and particularly Cub fans will recognize this picture of Hall of Famer Ernie Banks, “Mr. Cub”. Banks became well known for his catch phrase of, “It’s a beautiful day for a ballgame… Let’s play two!” In retirement plan terms, it’s the Pension Protection Act of 2006 (PPA) telling business owners that two retirement plans can be a beautiful thing. I know, I know that this is a stretch, but I’m trying to make tax stuff interesting.

The Pension Protection Act of 2006 (PPA) made some important changes in the funding of defined benefit pension plans. And for the business owner seeking to increase retirement plan contributions, these changes included increasing the deduction limits when maintaining both a defined benefit plan and a defined contribution plan, i.e., 401(k) and profit sharing.

Pre-PPA employers maintaining both types of plans were subject to a combined 25% plan deduction limit. But starting in 2006, these employers were still subject to that 25% limit but could make a profit sharing contribution of up to 6% of compensation without the amount being counted towards the 25% limit. And like prior law, if  401(k) plan contributions are limited to elective deferrals only, such a plan would be excluded from the deduction calculations. So using 2008 compensation and contribution limits, a business owner could make an additional contribution of up to $34,300 for 401(k) and profit sharing.

And it gets even better for plan years starting in 2008. For employers with defined benefit plans covered by the Pension Benefit Guaranty Corporation (PBGC), these plans are no longer subject to the 25% combined defined benefit/defined contribution deduction limit rules. This means that an employer with a PBGC-covered pension plan may take a deduction for the minimum funding amount even when it exceeds 25% of compensation, AND the employer may also take a deduction of up to 25% of compensation for the defined contribution plan.

And this opens the door for substantial contributions to cash balance pension plans by “professional service employers”, (law firms, accounting firms, and medical practices) with more than 25 active participants which are subject to PBGC-coverage and premiums. But that’s a topic for another day.


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