Improving personal finances not top 2008 New Year’s resolution

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

According to a recent survey (PDF) by Country Insurance & Financial Services, more people resolved to lose weight and exercise more (24%) or to spend more time with friends and family (23%) than plan to focus on improving money matters in 2008 (17%). Respondents also said that they’ll make better financial choices next year, although their actions may not be in line with their goals. While 75% said they are likely to make needed changes to their  finances in the year ahead, 40% claim they either do not have a financial plan (10%) or have not reviewed the one they have in the past year (30%).

Photo credit: ~~wv~~ via Flickr.

401(k) auto-enrollment: the shape of things to come

By Jerry Kalish on Posted in 401(k) Plans, Automatic Enrollment, Pension Protection Act of 2006

It’s the New Year, and it’s prediction time. So what’s ahead for employers in 2008? Paul Secunda in his post in The Workplace Prof Blog, 2008 Workplace Trends, points us to Diane Stafford’s predictions in the on-line edition of the Kansas City Star. Paul comments that

These all sound right to me, and I would add that there will be more ERISA class actions by 401(k) account holders, more use of Voluntary Employee Benefit Associations (VEBAs) to deal with the growing problem of retiree health care, and there will be more emphasis on helping employees returning from military service.

I agree, but let me add one more trend for 2008 that I consider an easy prediction to make: more employers adding auto-enrollment for 401(k) plans. The impetus for which is, of course, coming from the Pension Protection Act of 2006. Here are some of the early returns:

  • Schwab reports that more than 20% of its Retirement Plan Services clients now automatically enroll employees into a 401(k) plan (a four-fold increase from two years ago).
  • New York Life found that 32% of its 401(k) plan clients had adopted automatic enrollment as of September 30, 2007, up from 18% on January 1, 2007.
  • A recent Spectrem Group survey suggests that within two years, automatic enrollment will be in place at more than 80% of plans with $10 million or more in assets.

And how do employees feel about auto-enrollment? Very positively based on a recent survey by Retirement Made Simpler, a Washington, D.C.-based coalition that provides resources that help employers simplify the auto-enrollment process. Their survey found that the nearly 700 surveyed adults enrolled in an automatic 401(k) plan, 98% said they were glad their companies offered the retirement plan. But most significant to me was that of those employee who were automatically enrolled only 7% opted out.

Picture credit: The picture above is the album cover from George Benson’s 1968 album, The Shape of Things to Come, the remastered version of which was recently released by Verve Records. This was Benson’s debut album, and Verve says that "Shape of Things to Come is the true signal of Benson’s arrival, not only as a major soloist, but as an artist who refuses to be pinned down four decades later".

Year end tax planning to die for

By Jerry Kalish on Posted in 401(k) Plans, Audio/Visuals, Defined Benefit Pension Plans, Individual Retirement Accounts

"Taxman"

https://youtube.com/watch?v=jzLry3ABpV0%26rel%3D1

The producer of this video, WildCard Productions, calls it "a tribute to the greatest band’s greatest album". It is, of course, the Revolver album released in 1966, often cited as one of the greatest albums in rock music history, The song on the video, “Taxman”, was written and performed by George Harrison.

Harrison performs the song in the role of a taxman in a tongue-in-cheek manner. He was inspired to write "Taxman" when he discovered how much he was earning after accounting for taxes. As Harrison said,

"’Taxman" was when I first realised that even though we had started earning money, we were actually giving most of it away in taxes.

At the time, the top tax brackets in the U.K. and the U.S. were extremely high, 95% and 70% respectively. But that was then and this is now when tax rates are lower.

And it’s about the low tax rates in this country that Paul Ferraresi says, Hold Onto Your Wallets, in his blog, Financial Planning for Smart People. He reminds us that the 2001 and 2003 tax cuts are set to expire December 31, 2010. And regardless of Presidential politics, taxes will go up in the future. Taxpayers, he says, should meet with their advisers immediately to take action on strategies in 2007 with lower rates and do similar planning to take action in 2008.

But what about the estate tax which was also part of that tax reduction legislation? The 2001 tax bill  increased exemption amounts and reduced tax rates through 2009 with a complete repeal of the estate tax coming in 2010. But that repeal is only effective if a person dies in 2010. Unless there is a change in the law before then, the tax law completely reverts in 2011 to what it was prior to the enactment of the 2001 tax act: lesser exemptions and higher rates.

Is it possible, then, for a taxpayer to follow Mr. Ferraresi’s advice about tax planning under these circumstances? Would a taxpayer actually die to avoid taxes? Marc Abraham discusses exactly that in his article, Dying To Beat the Taxman on his Improbable Research Blog. He writes about a study by Joel Slemrod and Wojciech Kopczuk  that looked at what happened when the estate tax rate substantially increased on eight occasions. That occurred twice in 1917, and once each in 1924, 1932, 1934, 1935, 1940 and 1941. They also looked at what happened when the estate tax was decreased on five other occasions: in 1919, 1926, 1942, 1983 and 1984.

Their study, Dying to Save Taxes: Evidence from Estate Tax Returns on the Death Elasticity, indicated, they said, that there is a small death elasticity. In other words, there is evidence that some people will themselves to survive a bit longer if their heirs will have a smaller estate tax liability. As to the obvious other reason for this evidence, they said "we cannot rule out that what we have uncovered is ex-post doctoring of the reported date of death".

So let me conclude this discussion where I began: with "Taxman". Here’s George Harrison’s last stanza:

Now my advice for those who die, (taxman)
Declare the pennies on your eyes. (taxman)
‘Cause I’m the taxman,
Yeah, I’m the taxman.

And you’re working for no one but me.

Taxman!

 

 

 

 

 

 

Still time for self-employed to establish retirement plan for 2007

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

See full size image.

It’s that time of the year again. Yes, that time when tax advisers like Joe Kristen who writes the Tax Update Blog for Roth & Co., P.C., ask self-employed business people, Is A Qualified Plan a Good Move by Year End?.

So let’s assume that for personal financial and tax reasons the answer is yes. And further to keep it basic, let’s assume that only one individual is involved, and that person is “in business for himself or herself”. This means for retirement planning purposes, it’s someone who has self-employment income from a trade or business – so called “sweat of the brow” income rather than income received as dividends for example. And it can also include individuals with supplemental self-employment income such as:

  • Independent members of corporate boards,
  • University professors with consulting income,
  • Writers or others with royalty or licensing income, or
  • Anyone who otherwise receives any fees from sources other than his or her primary employment

For the self-employed, the tax laws have never been better to save money for retirement on a tax-deferred basis using a choice of retirement plans. And so again to keep it basic, let’s take a self-employed individual who has net earnings before the retirement plan deduction of $100,000. His or her options from a contribution standpoint could be these:

Profit Sharing $18,587.05
401(k) $15,500.00
401(k) Catch-Up   $5,000.00
Maximum Profit Sharing/401(k) $39,087.05
SIMPLE IRA $13,206.85
SIMPLE Catch-Up   $2,500.00
Maximum SIMPLE IRA $15,706.85
Maximum SEP $18,587.05

And this is even before a defined benefit plan with larger potential contributions can be factored into the equation. But as Joe tells us while the contribution doesn’t have to be made until the due date of the income tax return including the extension, the plan must be in place by year end. And there’s still time.

T-shirt version of the picture above is available through MindSpeaker.

What’s 1% worth?

By Jerry Kalish on Posted in 401(k) Plans

What’s 1% worth? In terms of an increased retirement benefit – a lot of money! Paul Secunda over at the Workplace Prof Blog provides us with an Illustration of How 401(k) Management Fees Add Up, and shows us the effect on earnings of even one percentage point difference in annual fees on a 401(k) balance of $20,000 invested over 20 years.

That’s during the accumulation phase. But what impact does a 1% increase in return have during the distribution phase. The chart above shows us that a 1% increase in returns, compounded over a lifetime, makes an enormous difference. In this example provided by Alliance Bernstein, it translates into about $220,000 extra at retirement—and an extra 10 years of spending.

So whether it’s during the accumulation phase or during the distribution phase, 401(k) fees really do matter.

For the mathematically inclined, following is the methodology Alliance Bernstein used to develop their chart:

Results are simulated. This is a hypothetical illustration only and its results are not indicative of any specific investment, including any AllianceBernstein mutual fund. The savings phase simulates a defined contribution participant salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25 increasing by 0.5% per year to a maximum 10% with a 50% company matching contribution up to the first 6% of salary. In the spending phase, $63,750 (75% of final salary) is deducted at the beginning of each year. A yearly investment return of 9% is assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. In the “1% Greater Return Scenario” a yearly investment return of 10% is assumed at age 25, linearly decreasing to 7% at age 85 and remaining constant thereafter. Inflation is assumed to be a constant 3% and dollar values are expressed in real purchasing power terms.

 

ESOPs aren’t forever, and neither is the ownership culture

By Jerry Kalish on Posted in Employee Stock Ownership Plans

ESOPs like other qualified retirement plans do terminate. For those of us who have been administering ESOPs for some time, we had the anecdotal evidence as to why. But not until recently has there been an actual study as to why ESOPs do terminate. The Employee Ownership Foundation today released the second phase of a final report on the reasons why companies terminate ESOPs. Phase I of the report found that while the most common reason for termination may be acquisition, and Phase II was conclusive that an attractive acquisition offer was the primary reason for ESOP termination.

For many of our ESOP clients, the offers were too good to turn down. The employee-shareholders received substantial financial benefits on the sale of their ESOP shares. These ESOP companies were successful because they combined employee ownership with participatory management. The buyers were larger companies with different cultures. And for some of these selling companies, it was the day the music died.

401(k) plan sponsors asking “what’s next?”

By Jerry Kalish on Posted in 401(k) Plans

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That’s the question that retirement plan sponsors are asking their advisors. So exactly what is next for 401(k) plans? Last month I wrote that the 401(k) arms race is over, the proliferation of features that 401(k) providers have been doing over the last 25 years to stay competitive. Now, says the research done by Alliance Bernstein, the global asset management firm, leading plan sponsors are focusing on whether their plans are effectively meeting their goals. They’re asking themselves five core questions:

  • Are we getting the best value for our money?
  • Are we meeting all of our fiduciary responsibilities?
  • Do we have the right investment lineup?
  • Do we provide a communication program that works?
  • Are we receiving the type of service we need?

I’ll add one more question plan sponsors are asking: "Are we effectively taking advantage of all the recent tax law changes?"

The answers are out there.

PIcture credit: "What’s Next", acrylic on canvas, available from Art by Wicks.

401(k) automatic enrollment or how to overcome employee inertia

By Jerry Kalish on Posted in 401(k) Plans, Automatic Enrollment, Pension Protection Act of 2006


Click to make bigger.

Inertia, in classical physics, is defined by Merriam-Webster’s Collegiate Dictionary as: “a property of matter by which it remains at rest or in uniform motion in the same straight line unless acted upon by some external force.” In 401(k) plans, inertia can be defined as many eligible employees never signing up for the plan – even when the employer makes a matching contribution.

The Pension Protection Act of 2006 addressed the legal aspect of this issue by adding provisions for automatic enrollment and the Qualified Default Investment Arrangement (QDIA). But concepts like this just don’t pop into the law. It took almost ten years of advocacy in this case.

One of those advocates was Mark Iwry. While serving in the U.S. Treasury Department, overseeing the regulation of the nation’s private pension system, Mark led the government’s initiative to define, approve, and promote automatic 401(k)s beginning nearly a decade ago.

Mark, no longer in government, told me recently that

The automatic 401(k) is a disarmingly simple concept: it enrolls employees at specified contribution levels and in a specified investment, but they can always opt-out, contribute more or less, or invest differently. This enlists inertia in the cause of saving, helping workers—especially moderate- and lower-income and minorities—save more and start earlier.

Mark is now involved with helping make automatic enrollment happen and "simpler". He is the Managing Director of the Retirement Security Project (RSP) and Nonresident Senior Fellow at the Brookings Institution. The RSP is part of a coalition called Retirement Made Simpler which includes the American Association of Retired People (AARP) and the Financial Industry Regulatory Authority (FINRA). Their common mission is to encourage savings through automatic 401(k).

And Retirement Plan Simpler does exactly that by providing research and resources including a Auto 401(k) Toolkit with sample employee communication materials.

And to make it simpler for you, here is a link to the Toolkit (PDF) on their website, and if you look to your left on this page, I’ve also added a link to their website under "Other Resources".

Picture credit: Scientist Activity Badge on Bill Smith’s Unofficial Cub Scout Roundtable

401(k) participant loans on the increase, but not always a good thing to do

By Jerry Kalish on Posted in 401(k) Plans

Tight credit and a slumping housing market that has reduced the use of home equity as a loan source is causing people to look in other directions to borrow money. And for those who are participants in 401(k) plans, there may be a loan provision in their plan to utilize. But there is a downside to consider. 

  • They’re losing the earnings on their accounts since there’s less money to invest.
  • The tax shelter advantage is lost since the loan is paid back with after-tax dollars.
  • The interest paid on the loan is not deductible since it’s considered regular consumer debt.
  • If the participant terminates employement prior to paying off the loan, the loan has to be repaid or it’s considered a taxable distribution with a 10% penalty tax if the participant is under age 59 ½ .

Here’s an example of the financial impact of a 401(k) loan from T. Rowe Price. Assume that the participant has been making monthly contributions of $264 to his 401(k) account and has been earning annualized return of 8%. Now at age 40, he takes out a loan for $50,000 for 5 years at an interest rate of 7%. His after-tax monthly loan repayment would be $198 and he halts his monthly contributions to the plan.

By taking the loan: 

  • His balance at end of 5-year payback period would be $74,143, and
  • His balance at age 65 would be $520,799.

But if he doesn’t take the loan: 

  • His balance at end of the 5-year payback period would be $93,891, and
  • His balance at age 65 would be $618,095.

Taking the 401(k) loan reduces the employee’s account balance by approximately 21% at the end of the 5-year payback period, and by approximately 19% at age 65.

Something to consider.

The short and unhappy life of the Michigan service tax

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

A new and unpopular Michigan 6% service tax on business died on Saturday less than 17 hours after it had taken effect. The tax officially became law at 12:01 a..m. Saturday, but later in the day the Michigan legislature approved a bill repealing and replacing the tax which Governor Jennifer Granholm later signed that same day.

Here’s the back story, and how it relates to the financial world. This past October the Michigan legislature added a new 6% sales tax to financial advisory services and other occupations considered “non-essential" which included astrology reading, escort services and ski lift ticketing. This new tax along with an increase in the income tax rate to 4.35% from 3.9% was an effort to meet a projected $1.75 billion budget deficit.

The new tax quickly spawned the Coalition to Ax the Tax, a group of more than 70 business and taxpayer groups including the Small Business Association of Michigan. Public pressure from the Coalition and its members played a lead role in getting the Legislature to consider the tax’s repeal.

The service tax will be replaced by a 21.99% surcharge on the taxes businesses will already pay under the new Michigan Business Tax, which takes effect January 1, 2008. Yes, politics is the art of the compromise.

Photo credit: redgoldfly on Flickr.

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