Saturday, September 23, 2017

"Checks" and Balances

In about a month, the IRS will announce the new contribution and benefit limits for 2018 – and that could be good news even for those who don’t bump against those thresholds.

These are limits that are adjusted for inflation, after all – designed to help retirement savings (and benefits) keep pace with increases in the cost of living. In other words, if today you could only defer on a pre-tax basis that same $7,000 that highly compensated workers were permitted in 1986 – well, let’s just say that you’d lose a lot of purchasing power in retirement.

But since industry surveys suggest that “only” about 9%-12% currently contribute to the maximum levels, one might well wonder if raising the current limits matters. Indeed, one of the comments you hear frequently from those who want to do away with the current retirement system is that the tax incentives for 401(k)s are “upside down,” that they go primarily to those at higher income levels, who perhaps don’t need the encouragement to save. Certainly from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes.

Drawing on the actual account balance data from the EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), the nonpartisan Employee Benefit Research Institute has found that those ratios were relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000. (See chart.) In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes – and not “upside down.”

And yet, according to Vanguard’s How America Saves 2017, only about a third of workers making more than $100,000 a year maxed out their contributions. If these limits and incentives work only to the advantage of the rich, why aren’t more maxing out?

Arguably, what keeps these potential disparities in check is the series of limits and nondiscrimination test requirements: the boundaries established by Internal Revenue Code Sections 402(g) and 415(c), combined with ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to do just that – to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

Those who look only at the external contribution dollar limits of the current tax incentives generally gloss over the reality of the benefit/contribution limits and nondiscrimination test requirements at play inside the plan – and yet surely those limits are working to “bound in” the contributions of individuals who would surely like to put more aside, if the combination of laws and limits allowed.

One need only look back to the impact that the Tax Reform Act of 1986 had on retirement plan formation following the imposition of strict and significantly lower contribution limits – as well as a dramatic reduction in the rate of cost-of-living adjustments to those limits – to appreciate the relief that came in 2001 with EGTRRA.

Anyone who has ever had a conversation with a business owner – particularly a small business owner – about establishing or maintaining a workplace retirement plan knows how important it is that those decision-makers have “skin in the game.”

While we don’t yet know what the limits for 2018 will be, gradually increasing the limits of these programs to keep pace with inflation helps assure that these programs will be retained and supported by those who, as a result, continue to have a shared interest in their success.

And that’s good news for all of us.

- Nevin E. Adams, JD

Saturday, September 16, 2017

Are You (Just) a Retirement Plan Monitor?

A recent ad campaign focuses on the distinction between identifying a problem and actually doing something about it.

In one version a so-called “dental monitor” tells a concerned patient that he has “one of the worst cavities that I’ve ever seen” before heading out to lunch, leaving that cavity unattended. Another features a “security monitor” who looks like a bank guard, but only notifies people when there is a robbery.

As an industry, we have long worried about the plight of the average retirement plan participant, who doesn’t know much (if anything) about investing, who doesn’t have time to deal with issues about their retirement investments, and who, perhaps as a result, would really just prefer that someone else take care of it.

What gets less attention — but is just as real a phenomenon — is how many plan sponsors don’t know anything about investments, don’t have time to deal with issues about their retirement plan investments, and who, perhaps as a result, would — yes, also really just prefer that someone else take care of it.

Of course, if many plan sponsors lack the expertise (or time) to prudently construct such a plan menu, one might well wonder at their acumen at choosing an advisor to do so, particularly when you consider that surveys routinely show that plan sponsors choose an advisor primarily based on the quality of the advice they provide. One can’t help but wonder how that advice is quantified (certainly not in the same way that investment funds can be), and doubtless, that helps explain why so many advisors are (apparently) hired not on what they know, but on who they know.

But for many plan fiduciaries, the obstacle to hiring a retirement plan advisor is financial, not intellectual. Particularly for a plan sponsor who has not previously employed those services — or, more ominously, in the case of one who has hired an advisor that didn’t hold up their end of the bargain — the additional costs of hiring an advisor can be problematic. The question asked of a prospective advisor may be, “Why should I hire you?” But one can well imagine that the question that is often unarticulated, and perhaps the real heart of the matter is, “Why should I pay you (that much)?”

There are ways, of course, to quantify the value of those services, ways that quantify not only what that advisor is worth, but why those fees are what they are. Some advisors promote their services as a shield against litigation, or at least some kind of buffer against the financial impact of such an event, but in my experience, while most employers are glad to get/take the “warranty” (implied or explicit), they often aren’t willing to pay very much extra for it.

In the most obvious case, you can walk in and demonstrate the ability to save a plan money by upgrades to the menu, a change in providers, or perhaps even a better negotiation of the current arrangement. That’s clearly added value, and value that is readily measured (though it has a finite shelf life). Assuming, of course, that the plan sponsor is ready, willing (and in some cases, able) to act on those recommendations.

Indeed, most of the attempts to affix a value to having an advisor tend to focus on investment returns or cost savings for the plan. Both are valid, objective measures that can have a real, substantive impact on retirement security for participants, and fiduciary peace of mind for the plan sponsor.

Similarly, the ability to increase plan levels of participation, deferral, and investment diversification also adds value — quantifiable value, particularly measured against goals and an action plan for achieving them that is clearly articulated, and updated, up front. Ultimately, it’s about more than identifying issues and problems, it’s about having a plan for the plan, and being willing to be an agent for change in pursuit of it.

The “monitor” ad closes with the admonition, “Why monitor a problem if you don’t fix it?”
Indeed.

- Nevin E. Adams, JD

See also: “The Value of Good Advice.”

Saturday, September 09, 2017

A "Real Life" Example

In addition to the books, reference guides, and a few personal “knick knacks,” I have for years had in my office a couple of model cars – but not for the reason people generally think.

These models happen to be Studebakers (a 1950 Champion, a 1953 Starliner and a 1963 Avanti). I’d wager that a majority of Americans have never even heard of a Studebaker, and the notion that a major U.S. automobile maker once operated out of South Bend, Indiana would likely come as a surprise to most. I keep them in my office not because I have an appreciation for classic cars (though I do), but because of the role the automaker played in ERISA’s formation.

Born into a wagon-making family, the Studebaker brothers (there were five of them) went from being blacksmiths in the 1850s to making parts for wagons, to making wheelbarrows (that were in great demand during the 1849 Gold Rush) to building wagons used by the Union Army during the Civil War, before turning to making cars (first electric, then gasoline) after the turn of the century. Indeed, they had a good, long run making automobiles that were generally well regarded for their quality and reliability (their finances, not so much) until a combination of factors (including, ironically, pension funding) resulted in the cessation of production at the South Bend plant on Dec. 20, 1963. Shortly thereafter Studebaker terminated its retirement plan for hourly workers, and the plan defaulted on its obligations.

At the time, the plan covered roughly 10,500 workers, 3,600 of whom had already retired and who – despite the stories you sometimes hear about Studebaker – received their full benefits when the plan was terminated. However, some 4,000 workers between the ages of 40 and 59 – didn’t. They only got about 15 cents for each dollar of benefit they had been promised, though the average age of this group of workers was 52 years with an average of 23 years of service (another 2,900 employees, who all had less than 10 years of service, received nothing).

ERISA did not create pensions, of course; they existed in significant numbers prior to 1974, as the workers at Studebaker surely knew (they certainly had reason to – Studebaker-Packard had terminated the retirement plan for employees of the former Packard Motor Car company in 1958, and they got even less than the Studebaker workers wound up with in 1964). But armed with the real life example of those Studebaker pensions, highlighting what had been a growing concern about the default risk of private sector plans (public sector programs weren’t seen as being vulnerable to the same risk at that time) – well, it may have been a decade before ERISA was to become a reality, but the example of Studebaker’s pensions provided a powerful and on-going “real life” reminder of the need for reform.

Has ERISA “worked”? Well, in signing that legislation – 43 years ago this past weekend – President Ford noted that from 1960 to 1970, private pension coverage increased from 21.2 million employees to approximately 30 million workers, while during that same period, assets of these private plans increased from $52 billion to $138 billion, acknowledging that “[i]t will not be long before such assets become the largest source of capital in our economy.” His words were prophetic; today that system has grown to exceed $17 trillion, covering more than 85 million workers in more than 700,000 plans.

The composition of the plans, like the composition of the workforce those plans cover, has changed considerably over time, as has ERISA’s original framework. Today much is made about the shortcomings in coverage and protections of the current system, the projections of multitrillion-dollar shortfalls of retirement income, the pining for the “good old days” when everyone had a pension (that never really existed for most), the reality is that ERISA – and its progeny – have unquestionably allowed more Americans to be better financially prepared for retirement than ever before.

It’s a real life example I think about every time I look at those model cars – and every time I have the opportunity to explain the story behind them.

- Nevin E. Adams, JD

Saturday, September 02, 2017

Storm "Warnings"

Watching the incredible, heart-rending coverage this past weekend of Hurricane Harvey’s devastation, I was reminded of a personal experience with nature’s fury.

It was 2011, and we had just deposited our youngest off for his first semester of college, stopped off long enough in Washington, DC to visit our daughters (both in college there at the time), and then sped home up the East Coast with reports of Hurricane Irene’s potential destruction and probable landfall(s) close behind. We arrived home, unloaded in record time, and rushed straight to the local hardware store to stock up for the coming storm.

We weren’t the only ones to do so, of course. And what we had most hoped to acquire (a generator) was not to be found – there, or at that moment, apparently anywhere in the state.
What made that situation all the more infuriating was that, while the prospect of a hurricane landfall near our Connecticut home was relatively rare, we’d already had one narrow miss with an earlier hurricane and had, on several prior occasions, been without power, and for extended periods. After each I had told myself that we really needed to invest in a generator – but, as human beings are inclined to do, and reasoning that I had plenty of time to do so when it was more convenient, I simply (and repeatedly) postponed taking action. Thankfully my dear wife wasn’t inclined to remind me of those opportunities, but they loomed large in my mind.

Retirement Ratings?

People often talk about the retirement crisis in this country, but like a tropical storm still well out to sea, there are widely varying assessments as to just how big it is, and – to borrow some hurricane terminology – when it will make “landfall,” and with what force.

Most of the predictions are dire, of course – and while they often rely on arguably unreliable measures like uninformed levels of confidence (or lack thereof), self-reported financials and savings averages – it’s hard to escape a pervasive sense that as a nation we’re in for some rough weather, particularly in view of objective data like coverage statistics and retirement readiness projections based on actual participant data.

Indeed, in a recent op-ed in the Wall Street Journal, Andrew Biggs, Resident Scholar at the American Enterprise Institute offers what is certainly a contrarian perspective these days: assuring President Trump (and us) that there is no retirement crisis (subscription required), at least not a “looming” one. And yet his point is basically little more than things are better than many would have us believe, based largely on data that indicates things are better now than they were before we worried about such things. Biggs, who previously testified before Congress that the use of the term “crisis” to describe the current situation was an “overblown non-solution to a non-crisis,” maintained that 75% of today’s retirees are “doing well,” and that Boomers are having a better retirement than their parents, who ostensibly lived during the “golden age” of pensions.

Another reassuring perspective was published earlier this year by the Investment Company Institute’s Peter J. Brady & Steven Bass, and Jessica Holland & Kevin Pierce of the Internal Revenue Service – who found, based on IRS tax filings, that most individuals were able to maintain their inflation‐adjusted net work‐related income after claiming Social Security. Not exactly an affirmation that the income was enough to sustain retirement expenses, but at least it showed that individuals were maintaining (and most improving upon) their pre-retirement income levels, at least for a three-year period into retirement.

Life is full of uncertainty, and events and circumstances, as often as not, happen with little if any warning. Even though hurricanes are something you can see coming a long way off, there’s always the chance that they will peter out sooner than expected, that landfall will result in a dramatic shift in course and/or intensity, or that, as with Hurricane Katrina – and apparently Harvey – the most devastating impact is what happens afterward. In theory, at least, that provides time to prepare – but, as I was reminded when Irene struck, sometimes you don’t have as much time as you think you have.1

Doubtless, a lot of retirement plan participants are going to look back at their working lives as they near the threshold of retirement, the same way I thought about that generator. They’ll likely remember the admonitions about (and their good intentions to) saving sooner, saving more, and the importance of regular, prudent reallocations of investment portfolios. Thankfully – and surely because of the hard work of advisors and plan sponsors – many will have heeded those warnings in time. But others, surely – and particularly those without access to a retirement plan at work – will find those post-retirement years (if indeed they can retire) to be a time of regret.

Those who work with individuals trying to make those preparations know that the end of our working lives inevitably hits different people at different times, and in different states of readiness.
But we all know that it’s a “landfall” for which we need to prepare while time remains to do so.

- Nevin E. Adams, JD

Footnote
  1. As it turned out, we got lucky. An apparently random and unexpected delivery of generators happened at our local hardware store where my wife had only hoped to be able to stock up on batteries. We got it home, and in record time learned enough to run it, managed to get in a supply of gasoline (before the pumps and cash registers ran out of juice), got our windows covered with plywood, and hunkered down for what still feels like the longest night of my life.