Retirement Planning

The vast majority of those reading this submission find themselves, either currently or prospectively, saving for retirement using a defined contribution plan (such as a 401(k) plan), rather than the defined benefit pension plans that our parents or grandparents enjoyed. This is because few employers, other than governments, can afford to fund traditional pensions. Instead, we live with defined contribution plans, where our ultimate benefits will depend on our level of funding, our employer’s optional matches, and the performance of the securities markets throughout our lifetimes. Gone are the days when we would work for a corporation for 35 years and they would tend to our needs throughout our remaining lifetimes.

The new prototypical retirement involves our leaving our employer and:

• Rolling our 401(k) plan balance into an IRA that we manage ourselves or hire someone to manage for us.
• Collecting social security, depending on our ages when we start (waiting to age 70 maximizes our draw) and our work and social security payment history.
• Assembling our after-tax investments, such as securities accounts, investment properties, or our principal residence to determine what cash flow might be attainable.

We will discuss at another time the issue of proper investing of, and withdrawal rates from, retirement assets, assessing the likelihood of out-living our limited retirement assets, but let us discuss some sobering numbers:

• The federal General Accounting Office says around 29% of households age 55 and older have no retirement savings or accounts.
• The federal Census Bureau says the average net worth for an American age 55-64 (excluding home equity) is $45,447.
• Social security, with an average monthly benefit for retired workers of $1,354.04 as of October 2016, was intended to be a safety net or insurance policy, not a sole source of retirement income.

What can we do today to protect against outliving our retirement resources? Let us focus on a slightly more favorable example:

• Joe, age 70, has been making $150,000 per year but is retiring with an accumulated 401(k) balance of $1 million, that he is transferring to an IRA. Mary, Joe’s wife is also 70.
• Joe’s social security benefit, when he claims at age 70, will approximate $3,600 per month. Mary did not earn social security.
• Joe and Mary have non-retirement investments and savings of $500,000.
• Assuming 80% of prior salary in retirement, Joe and Mary would need $10,000 per month in cash flow.
• If they invested the IRA and withdrew 4% per annum, that $40,000, or $3,333.33 per month, would add to the $3,600 per month social security, leaving just over $3,000 per month shortfall to be paid out of after tax investment assets.
• What would happen if the markets had a 50% drop in value as happened in 2000 or 2008? The resulting $500,000 IRA balance results in $1,670 per month from the IRA at a 4% withdrawal rate, furthering the cash shortfall.

This is where we depart the accepted, conventional world of fee-only financial planning and stride boldly into the world of the commissioned brokerage industry. One solution to this risk and this cash shortfall is the use of a single payment immediate income annuity (SPIA). Let’s revisit our last scenario using the SPIA solution:

• Assume $500,000 of the IRA were used to purchase an annuity, payable for the joint life expectancy of Joe and Mary.
• $2,859.66 would be payable monthly during Joe’s life, decreasing by one-third upon his death, through Mary’s life.
• So long as Social security and the insurance company issuing the annuity survive, Joe and Mary will receive $3,600 + $2,859.66 = $6,459.66 per month until Joe passes and slightly less thereafter. Basically two-thirds of their cash flow nut has been covered by a pension that they created with social security and a SPIA.
• The projected $1,670 from the IRA (based on 4% of the $500,000 balance) and whatever can be generated from after tax investments should be able to make up the other third of needed cash flow. The IRA could be invested more robustly, because the annuity is supporting their cash flow needs.

Please note that interest rates are still near historic lows and the rates payable on SPIAs lock in at the time of purchase and will increase if and when market interest rates increase, making these numbers even better. If your retirement strategy can allow time for rates to rise, patience is encouraged.

In the past, annuities have been used to generate fees to brokers, to the potential detriment of the client. Placing expensive variable tax-deferred annuities into tax-deferred IRAs (“layering your tax deferral”) is tough to justify under a fiduciary standard. Nevertheless, there exist times and places for low-cost SPIAs in the crafting of your “do-it yourself” pension plan.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

Today we discuss five questions to ask yourself five years prior to retiring.

How Long Will You Live?

• This is my default response to the question “Do I Have Enough Assets to Retire?”
• Mortality tables indicate that a male age 65 has a mortality age of 84, meaning that half of all men who are 65 today will die before age 84 and the other half will still be alive, needing assets to live.
• Also, while a male age 65 has a 50% chance of living to 84 and a female age 65 has the same 50% chance of living to 86, as a couple, they have a 45% chance of one of them living to age 90.
• My father is going strong at 95, which sounds like a good number to plan on. Retirement assets should last at least 30 years.

Where Will You Live?

• Different zip codes can have very different costs of living.
• If you live close to family members, it could lower travel expenses, but raise other expenses.
• Some areas may offer more opportunities for part-time work or business activities.
• Lifestyle issues such as climate, cultural and recreational opportunities and access to effective medical care should all be considered.

What Will You Do?

• Will you spend your time generating expenses or income?
• Extensive first class travel, Broadway shows and gourmet dining can be expensive over time.
• Work during retirement saves expenses on travel and entertainment, while generating income.
• Volunteer work can be rewarding, emotionally, psychologically and (perhaps) financially (income tax deductions).
• Starting a business during retirement should be quite rewarding on several levels and eventually be profitable. Resources will be needed for start-up expenses and funding losses from early operations. Early cash drains hopefully result in later cash gains.

 How “Large” Will You Live?

• Whether you are traveling, working or hanging out at home, you can do so in a “large” or in a “simple” manner. Nothing is wrong with “living large,” you just must budget for it.
• Some retirees scale back in retirement and live the simple life. Pursuits might include gardening, taking long walks and reading great books. You can do a lot with little if you enjoy living simply.
• Other retirees feel they have been imprisoned in an office for 30 years and are entitled to live the good life. They want to travel, eat out often and well, explore expensive hobbies and “live the dream.” This can require great resources, but can be rewarding if you can afford it.

How Lucky Will You Be?

• Your future health is perhaps the largest unknown variable.
  • While our life expectancies continue to increase, no guarantees can be made as to what the quality of life for these extended years will be.
  • Medicare and medigap supplemental insurance will handle the bulk of the major medical expenses, but not long term assisted living or nursing home expenses.
  • The healthier you are, the more likely you are to need long-term care for the frailties that come with extended lifespan. Long term care insurance is a good hedge against these expenses.
  • The recent sharp spikes in medical expenses beg the question of what they might be in 20 years. Medical expenses are likely to become an ever higher percentage of retirement expenses. Chronic issues, such as Alzheimer’s, can be devastating to a budget.

• Your Family could have significant financial needs. Economic risk and divorce risk can be hard on your children and grandchildren.
• Economic disasters, such as the Great Recession of 2008, can wreak havoc on your retirement assets. Many retirees returned to work after their retirement assets were ravished by a 50% drop in the stock market.
• Physical disasters, such as floods, tornadoes or hurricanes occur too often, sometimes with ruinous effect. Complete insurance coverage is a necessity.

None of us knows what lays in wait for us during retirement. It is prudent, however, to ponder these issues far enough in advance of your retirement date, to enable you to make appropriate changes in your plans or delay your retirement date until adequate resources are available.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

We conclude our review of the recommendations in the Bipartisan Policy Center’s (“BPC’s”) report on the future of retirement security (the “Report”).

II. Promote Personal Savings for Short-Term Needs and to Preserve Retirement Savings for Older Age

• The Report indicates that 57% of individuals are not financially prepared for an unexpected shock to their financials, requiring early withdrawals from retirement plans or reliance on payday lenders.
• Minimize leakage from retirement plans from early withdrawals by harmonizing the early withdrawal penalties between IRAs and 401(k) Plans.
• Simplify the process for transferring accounts from plan to plan, to avoid cash-outs. Make it easier for employers to allow savings and enrollments in multiple savings plans.

III. Facilitate Lifetime-Income Options to Reduce the Risk of Outliving Savings

• Longevity risk presents one of the largest threats to retirement security.
  • Unlike Defined Benefit (“DB”) plans that provide retirement payments for life, Defined Contribution (“DC”) plans, such as 401(k) plans, provide no such guarantees. IRA and 401(k) plan balances are subject to market risks and can be significantly depleted in short order, such as occurred in 2008.
  • Tools addressing longevity risk are available in the marketplace, including insurance products (annuities) that guarantee payments for life, as well as non-guaranteed options that generate a sustainable regular payment that keeps up with inflation.
  • In 2014, the IRS allowed the use of Qualifying Longevity Annuity Contracts (“QLACs”) in DC plans. Up to 25% of plan assets may be used to purchase a longevity annuity that begins monthly payments as late as age 85 and continues for lifetime of a participant and a surviving spouse, thereby decreasing longevity risk.
• The Report encourages
  • Safe harbors to encourage employers to include lifetime income alternatives in DC plans, by limiting fiduciary liabilities.
  • Enabling more DC plans to offer automatic installment purchases (laddering) of lifetime income products. This reduces the risk of buying an annuity contract at the wrong time, such as when interest rates and annuity payments are low.
  • Encourage sponsors of DC plans through safe harbors to educate participants about the benefits of using plan assets to defer claiming social security as long as possible. The 5-8% annual increase in monthly payments for deferring claiming from 62 to 70 present a significant return and hedge against longevity risk.

IV. Facilitate the Use of Home Equity for Retirement Consumption

• Home Equity is a valuable retirement asset, which can be accessed through downsizing, home equity lines of credit (“HELOCs”) or reverse mortgages. Owners must be incentivized to retain their equity for use in retirement, rather than using it to support pre-retirement consumption.
• The Report recommends that tax deductions be removed from mortgage interest on HELOCs, second home mortgages or refinancing transactions, thereby encouraging homeowners to retain their home equity for retirement security.
• The Report encourages more use of reverse mortgages.

V. Improve Financial Capability Among All Americans

• Incorporate personal finance into K-12 and university curriculums.
• Better communicate the advantages of claiming social security later.

VI. Strengthen Social Security’s Finances and Modernize the Program

• The Social Security Trust Fund is expected to run out of funds in 2035, so this is the most exhausting area of investigation and recommendation in the Report.
• Matching proposals of increases of benefits for the lower paid with increased lifetime payments by the higher paid.
  • Establish a minimum benefit to keep all recipients out of poverty in retirement.
  • Index the retirement age to longevity, increasing full retirement age from 67 to 69 over many years.
  • Limit spousal benefits for higher earning couples.
  • Raise the maximum taxable earnings level from the current $118,500 to $195,000 in 2020 and index to wage growth thereafter.
  • Increase the payroll-tax rate by 1 percentage point by 2026, to 13.4%.
  • Increase taxes on benefits for high earners.
  • Improve the Disability Insurance Program before it is depleted at the end of 2016.

Modern employers were unable to afford the traditional DB Pension Plans offering guaranteed lifetime income payments, so DC Plans, such as 401(k) Plans, were implemented in the 1980s. The responsibility was transferred from employer to employee, but employee education and motivation as to the required level of funding to support retirement have been woefully inadequate. When Social Security was implemented in 1935, the retirement age was 65 and the average life expectancy in the United States was 61, versus 79.3 today. Social Security was designed as a safety net, not a retirement plan. The Report provides thoughtful recommendations on fixes for the funding issues, as well as the disbursement issues (annuities). The discussion on repairing social security is one of many, but has some excellent ideas. One need not accept all of the Report’s recommendations, but one must accept that the issues must be addressed in short order.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

It is time to review the much heralded recommendations to improve retirement security and personal savings in the Bipartisan Policy Center’s (“BPC’s”) report on the future of retirement security (the “Report”). The recommendations track the six challenges we have discussed previously.

Improve Access to Workplace Retirement Plans 

1. Create Retirement Security Plans For Businesses Under 500 Employees
   • Allow small employers to band together to form and join well designed and low cost, ERISA-protected, Retirement Security Plans (“RSPs”).
   • RSPs would have safe-harbors to avoid discriminatory testing and would allow employers to delegate the fiduciary duties to professional managers, who would be certified and regulated by the Department of Labor (“DoL”).
2. Enhance Automatic-Enrollment Contribution Safe Harbors
   • Exempt employers from testing if they automatically enroll employees in a plan with a default contribution rate between 3 and 10 percent of pay.
   • Employers could match up to 15% of pay, encouraging higher deferral rates by employees.
3. Enhance the Existing myRA Program to Benefit Uncovered Workers – Treasury implemented myRAs in 2015 for part-time or low-paid employees. Report suggests codifying the myRA outside of ERISA and allowing automatic enrollment and employer contributions, easing the process for employers to adopt them.
4. Introduce a National Minimum-coverage Standard to Pre-empt Disjointed State Standards
   • Effective in 2020, after the changes to RSPs and myRAs have been implemented, employers with over 50 employees must offer an ERISA plan (401(k)) or automatically enroll employees into either an RSP or a myRA.
   • Employers not wishing to adopt such a plan would simply forward contributions with their payroll taxes, to be segregated into a national or regional RSP.
5. Encourage Plan Sponsors to Assist Participants in Allocating and Diversifying Investments – new safe harbor to limit legal liabilities for plans that automatically reallocate into qualified default investment alternatives that gradually adjust to a more conservative allocation over time.
6. Allow Plan Sponsors to Establish Roth or Tax Deferred Default Treatment Depending on the Participant’s Tax Bracket.
7. Create Lifetime Income Plans as a Solution to Shortfalls in Funding for Multi-employer (Union) Defined Benefit Plans – offer a solution to underfunded multi-employer plans that might default, making them more sustainable and reducing taxpayer liability for defaults. Benefits would be a monthly payment for life.
8. Create a Private-Sector Retirement Security Clearinghouse to Help Individuals Consolidate Retirement Accounts and Assets – solve the problem of orphaned accounts at former employers and allow a more cohesive retirement network.
9. Establish New Limits on Company Stock in Defined Contribution (“DC”) Plans to Avoid Investment Catastrophes
   • Remember Enron? Too much employer stock can increase risk that major drops in retirement account value coincide with a loss of employment.
   • Employees should be educated as to the risk and no more than 25% of any retirement account should be employer stock.
10. Change Congressional Budgeting Rules to Use More Accurate, Longer Term Forecasts – official budget estimates limited to 10 years often overstate the impact of tax deferral of DC Plans because only the tax deferral is considered, not the later tax revenue when distributions occur.
11. Promote Plan Adoption by Increasing New-Plan-Startup or Auto-Enrollment Tax Credits – increase the credit to $4,500 of Plan start-up expenses, but require automatic enrollment provisions be included.
12. Change the Current Saver’s Credit to a Refundable Starter Saver’s Match to Incentivize Younger Savers – for lower earning workers aged 18-35, use a refundable (payable even with no tax liability) Starter Savers Match to match up to $500 contributions to a plan, with the match going directly into the plan.
13. Establish an Overall Limit on Total Assets in Retirement Plans to Reduce Taxpayer Subsidies to Wealthy Americans
    • The federal GAO estimates 1100 taxpayers have IRA balances over $10 million.
    • Proposed that no more than $10 million (indexed for inflation) be allowed in tax-deferred accounts.
14. End the “Stretch” IRA Technique – require non-spousal beneficiaries to distribute inherited retirement assets over a 5-year period, not their life expectancies. Accelerate payment of tax.
15. Exempt Small DC Plans and IRA Balances (Up to $100,000) From Required Minimum Distribution Rules – simplify the process and preserve balances for emergencies.
16. Exclude the First $25,000 of Savings in Retirement Plans from Means Tests for Public Support Programs – programs such as Food Stamps, Medicaid or SSI, are subject to means tests. Exempting the first $25,000 of retirement savings will encourage savings by many who most need the access to resources.

We will continue this review next time. I hope the reader appreciates the utility and practicality, yet creativity, of these recommendations by this expert Commission, despite this summary treatment. These ideas likely are a good representation (at least in part) of the future of retirement planning in the U.S. and are worthy of your consideration.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

Today we continue to review the six challenges for retirement security and personal savings in the Bipartisan Policy Center’s (“BPC’s”) 146 page report on the future of retirement security (the “Report”).

3. Americans Are Increasingly at Risk of Outliving Their Savings
   • An American male born in 2000 will have a 20-year life expectancy at normal retirement age of 65, 6 years longer than if he had been born in 1900. For women the life expectancy increased by 5 years, to 23 years [Report].
   • On average, 31% of women and 20% of men will live to age 90 and 45% of couples will have at least one survive to 90 [Report].
   • Defined Contribution (“DC”) Plans, such as 401(k) Plans, put the burden of determining the future retirement assets needed on the employees, who do not know how long they will live or what their investments will do.
   • Experts debate over whether a safe withdrawal rate is 3%, 4% or 5%. The IRS requires Minimum Required Distributions at age 70 1/2 that start at 3.65% and increase annually [Report].
   • One solution might be to purchase a lifetime annuity contract, in which an insurance company provides a stream of monthly payments guaranteed for life in return for a premium payment. Retirees transfer longevity and investment risk.
   • Only 20% of retirees purchase annuities contracts or opt for the monthly payments from a pension plan, most take a single-sum distribution [Report]. It is very hard to surrender access to large amounts of retirement money if they might face a large expense or if they die shortly after purchasing an annuity. Riders to annuities that provide such access are available, but expensive.

4. Home Equity is Underutilized in Retirement
   • Americans own more than $12.5 billion in home equity, nearly equaling the $14 billion in retirement savings [Report].
   • More than 50% of all homeowners over 62 have more than half their net worth held in home equity [Report]. Many older Americans will have to rely on home equity to supplement social security. 
   • But how will this be accomplished?
     • Down-sizing and freeing the equity for other uses.
     • Second mortgage or home equity line of credit (HELOC).
     • Reverse mortgages require no mortgage payments until the owner passes away or sells.
   • The number of older households with indebtedness (primarily tax-deductible home indebtedness) has doubled in the last 25 years [Report].
   • Holding mortgage debt limits retirees’ ability to tap home equity for supplemental cash flow, increasing risk.

5. Many Americans Lack the Basic Financial Knowledge to Prepare for Retirement
   • Many Americans are unfamiliar with fundamental financial principals, such as compounding interest, investment diversification and the impact of fees on account performance. This obviously results in lower balances in retirement plans, even if the participant has been diligent in funding them. 
   • Sponsors of 401(k) plans serve a fiduciary role, acting in the sole interest of plan participants, but IRA sponsors are not necessarily held to the same standard. Brokers are only held to a lower suitability standard. The recent DoL Fiduciary Rule, which we have discussed thoroughly in previous submissions, provides a key protection.

6. Social Security (“SS”) is at a Crossroads
   • In 1940, the first year that SS paid monthly benefits, 220,000 qualified for benefits. SS has expanded both the benefits payable and the potential beneficiaries so that, in 2014, 48 million beneficiaries collected $707 billion in benefits. The payroll tax rate has increased six-fold times, while the maximum amount subject to the payroll tax has more than doubled (inflation adjusted) [Report].
   • SS provides over 70% of the disposable income of seniors in the bottom 40% of the lifetime-earnings distribution [Report], but SS was not designed to be the sole source of income for retirees.
   • SS faces major financing challenges, already paying out more in benefits each year than it collects. The SS trustees project that the SS trust fund will be exhausted by 2034, when revenues will only cover 77% of SS obligations, necessitating benefit cuts, tax increases or a change in the historical funding mechanism [Report].
   • The ratio of covered workers paying into the system has dropped relative to the seniors drawing benefits from roughly 4-1 in 1965, to under 3-1 in 2015, and projected at 2-1 by 2030 [Report]. This is compounded by the earlier discussed increase in life expectancy.
   • SS provides a base for retirement, but should not be the primary cash flow source, particularly given its potential changes in the not so distant future.

We have discussed the issues. Next time we will look at the Report’s proposed solutions.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

Let us resume where we ended last time, with our discussion of the Bipartisan Policy Center’s (“BPC’s”) 146-page report on the future of retirement security (the “Report”). Today we will start to address the six challenges for retirement security and personal savings we mentioned last time.

I. Too Many Americans Lack Access to Workplace Retirement Plans—

• Traditional pensions were defined benefit (“DB”) plans, guaranteeing covered employees (who met a minimum-service requirement), a specified portion of their salary from retirement until death, requiring the employer to properly fund and manage the DB funds.
• Traditional DB plans benefitted individuals who worked for an employer for many years, retired and qualified for benefits based on their last few years’ earnings levels.
  • This equation disadvantages workers who are laid off or leave their employer years before they are eligible to retire or whose DB plan is closed by their employer mid-career.
  • Their benefits are significantly eroded because they do not include the wage gains between the ending of participation and the actual retirement.
  • DB plans were by no means perfect, but they placed the responsibility in the hands of the employer, not the employee.
• 401(k) plans were defined contribution (“DC”) plans that were introduced in 1978 to supplement (not replace) DB pension plans.
  • Employers saw that 401(k)/DC plans provided employees an opportunity to accumulate significant sums for retirement, without the cost and risk to the employer of DB traditional plans. The onus shifted from the employer to the employee.
  • The assets in private DB plans have dropped since the early 1980s to $2.9 trillion, while DC plan have ballooned to $6.7 trillion. [Report].
• Many state and local governments still provide their employees with generous DB plans, but many are severely under-funded, raising issues as to how they will be paid.
• Only about two-thirds of private sector employees have access to an employer-sponsored retirement plan of some sort, and, of those, three-fourths participate, for an overall 50% participation rate. [Report].
  • Many workers in the service industry, in part-time or low-wage jobs or at small firms, lack access to DC plans. A 2012 study found that 71 percent of employees in large (100+ employee) private sector firms participated in a plan, versus 42 percent at smaller firms. [Report].
  • Workers who do not have access to workplace plans do not usually open and fund IRAs instead. In 2012, contributions to private-sector DC plans were ten times the size of those to IRAs. [Report].
• The lack of retirement plans is likely due to the complexity and expense to the employer of managing them.
  • Much of this burden has been alleviated in the last ten years, through changes such as automatic enrollment, requiring those who do not wish to participate to opt out, and automatic escalation of deferrals, up to a certain limit.
• The nostalgic story of the college graduate going to work for a corporation, moving up the ranks, and retiring forty years later with a full pension, has all but disappeared. Today’s success story is transient, working in numerous situations during his/her career. Rules have placed the responsibility for funding the retirement plan on the employee, with the employer potentially matching deferrals. The retirement assets are housed in a 401(k) plan that can be moved from employer to employer during one’s career and eventually rolled over to an IRA upon retirement. Employees have been given portability of their retirement assets in exchange for the obligation to fund them. This is more consistent with today’s mobile work force, but not necessarily consistent with our cash flows needs during retirement.

II. Many Americans Lack the Resources to Save for Short-Term Needs

• An emergency fund serves as protection against unexpected shocks, but nearly half of individuals polled said that they could not come up with $2,000 in 30 days without selling possessions or taking out payday loans. [Report].
• Section 529 savings plans assist with higher education expenses and health savings accounts assist with health insurance deductibles.
• Leakage from workplace retirement plans, from plan loans, hardship withdrawals and cash-outs, remain significant issues.
• As a general rule, workers who are able to accumulate retirement savings and keep them intact during their working years are FAR more likely to be living well in retirement.

Discount these scary statistics any way you wish, but it seems inevitable that at some point in the near future there will be innumerable Baby Boomers retiring without adequate savings to provide for themselves during their remaining years. How will we fund this additional financial strain?

We will address more challenges in our next submission. Until we meet again… SAVE!

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

For the past two years, the Bipartisan Policy Center (“BPC”), a commission (a.k.a., Washington, D.C. Think Tank) made up of 19 high-profile experts from the political, business, academic and investment worlds, has been developing a plan to strengthen the retirement security and personal savings of all Americans. Quoting from its website, “The Bipartisan Policy Center is a non-profit organization that combines the best ideas from both parties to promote health, security, and opportunity for all Americans. BPC drives principled and politically viable policy solutions through the power of rigorous analysis, painstaking negotiation, and aggressive advocacy.” The BPC’s 146-page report (the “Report”) was released on June 10, 2016 and represents a key consideration in our ongoing discussion of retirement issues.

• The Report addresses changes expansively, ranging from 401(k) plans to savings tax credits to reverse mortgages.
• Employer funded defined benefit plans (the traditional pension plan) have largely been replaced with defined contribution plans, such as 401(k) plans, that employees have to finance and manage, but only half of private-sector workers who have access to such plans take advantage of them.
• Nearly half of the respondents to the Federal Reserve’s 2014 household survey indicated they would not even be able to cover a $400 financial emergency without selling assets or borrowing money, let alone actively saving for retirement. [Consider that for a moment].
• Social security is, by default, the main source of retirement income for older Americans and we are all familiar with funding issues involved with this 1937-vintage program.

The Report recommends fixes for six challenges to retirement security and personal savings:

• Improve access to workplace retirement savings plans
• Promote personal savings for emergency and retirement needs
• Facilitate lifetime income options to reduce risks of outliving savings
• Facilitate use of home equity for retirement cash flow
• Improve financial knowledge and capability of the American public
• Strengthen Social Security’s finances and modernize the Program

The Report’s proposals of interest to higher income taxpayers include:

• Limit tax deductibility of mortgage interest—
  • Mortgage interest deduction is only available to those who itemize their deductions on their Form 1040, generally wealthier taxpayers.
  • Increasing levels of debt, including more mortgage debt for older people, is of great concern to the BPC. More debt in retirement increases retirement risk, when income is lower and positive cash flow is of ultimate import.
  • The Report recommends tax deductibility be removed for mortgage interest when:
    • Home equity decreases, such as with home equity lines of credit;
    • Second mortgages reduce home equity;
    • Mortgage debt is for second homes; and
    • Refinancing transactions.
  • The goal is to encourage homeowners to retain equity in their homes to serve as a safety net of additional cash flow in retirement, through denying existing tax deductions.
• Cap total assets permitted in tax-advantaged retirement accounts at $10 million—
  • This may appear to be one of those “good news” problems, but the Government Accountability Office estimates that 314 taxpayers have more than $25 million in IRAs and 791 taxpayers have between $10 and $25 million.
  • If the reader is one of these 1100 fortunate taxpayers, your deductibility might be limited. Life could be worse…
• Shrink Social Security benefits for the wealthy—
  • Increase the taxable level of annual social security earnings to $195,000 from the current $118,500 level by 2020.
  • Hike the employer and employee payroll tax for social security, each by 0.5 percent, to 6.7 percent (13.4 percent in total).
  • Cap the spousal benefit for wealthy couples.
  • While some of the above provisions burden the ultra-wealthy, these provisions saddle working taxpayers with significant additional payroll taxes. Subjecting an additional $76,500 to 6.7 percent payroll tax results in an additional $5,125 in tax on a worker earning under $200,000 annually. Clearly impact is not limited to the “super-rich.”
• Close the ‘Stretch’ IRA estate planning loophole—
  • IRA beneficiaries are currently able to ‘stretch’ the distributions from inherited IRAs over their life expectancies, delaying their taxability.
  • The Report suggests that these distributions be required over a five-year period.

The BPC’s co-chairman stated that if the Report’s recommendations are enacted, ”retirement savings for middle-class Americans would be increased by 50 percent by 2065” and old-age poverty would be reduced by one third of today’s levels. Such lofty accomplishments must be paid for by someone and, accordingly, demand a more in-depth inspection, which we will undertake in future submissions.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

Before we broaden our investigation into retirement planning, let us take a moment to consider the heated activity on the DoL’s Fiduciary Rule for investment advisors to retirement plans. Please refer back to my previous two submissions if this discussion is new to you. In the two months since the Rule was passed on April 8, 2016:

• The House passed a bill to revoke the rule on April 28, 2016.
• The Senate passed a bill to revoke the rule on May 24, 2016.
• President Obama promised to veto any such bill that reaches his desk.
• The SEC announced on May 20, 2016, that it expects to release its version of the fiduciary rule in April 2017 [after a new President takes office].
• Four financial advice trade associations, the U.S. Chamber of Commerce and four other related groups filed a lawsuit on June 1, 2016, in the U.S. District Court for the Northern District of Texas (Dallas), where the Fifth Circuit Court of Appeals is believed to be particularly friendly to the financial industry, rather than consumers.
  • The U.S. Supreme Court’s current 4-4 split could result in them making no decision and leaving the 5^th Circuit’s decision as the final word.
  • First, the case will face a three judge appeals panel and then possibly an en banc hearing and decision by the Fifth Circuit.
• The next day, June 2, 2016, the National Association of Fixed Annuities filed a similar lawsuit in the U.S. District Court for the District of Columbia.
• Both lawsuits allege that the fiduciary rule, the best interest contract exemption and the other related prohibited transactions are “arbitrary, capricious and violate the First Amendment to the Constitution. The [Rules] should be vacated and the [DoL] should be enjoined from implementing or enforcing them in any nature.” [The Complaint].

The industry plaintiffs argue that they should not have to spend the resources to implement the rule, until courts have approved it, and the next administration is in place. The DoL responds that the rule has had a huge amount of exposure and is lawsuit proof. All parties acknowledge that delaying until after the presidential election could result in the death of the rule, depending on who is elected. Perhaps the industry plaintiffs believe that either new administration will be more user-friendly than the current administration and just want a delay. They had successfully deadlocked the SEC and Congress into no action positions on the fiduciary rule, but who would have thought it could come from the DoL? They were mistaken in their beliefs.

Why, again, do we care about the fiduciary rule?  Why can we not let the brokerage industry operate as they always have, subject to a lower suitability standard and free to charge whatever fee the account will bear?  What is so special about qualified retirement plans and IRAs that they require a separate fiduciary rule and more protection than our individual investments with our brokers? Why should investors have access to the state and federal court system for their complaints, rather than a broker-friendly arbitration system interpreting the contract of adhesion that the modern day brokerage contract has become?

Perhaps a more pertinent question is why has the brokerage industry brought out every possible means of blocking what has been described as a “watered-down,” “toothless” fiduciary investing rule? Why are they so concerned about being held to a fiduciary standard of care in acting on behalf of their clients? What about brokers’ means of compensation is not fair to the client and why do they insist on maintaining these unfair practices? Why should delaying implementation of the fiduciary rule beyond the scheduled April 2017 effective date [thereby giving them time to once again freeze the rule into legislative and regulatory limbo] serve as a victory to those who wish not to be considered fiduciaries to their clients?

When we return to the trials and travails of funding an adequate retirement in the next posting, we will likely appreciate the utility of having our advisors acting in a fiduciary manner, with our best interests in mind, when they handle our precious retirement assets.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

In the last submission we discussed the various definitions and requirements of the DoL’s new Fiduciary Rule on ERISA qualified retirement plans (such as 401(k) plans and pensions) and IRAs. We now turn to exemptions from application of the new rules and what the long-term impact of the rules might be.

• The new fiduciary rules apply ERISA’s prudence and exclusive client benefit rules, as well as the prohibited transaction rules, to investment advisors to retirement plans. ERISA prohibits a fiduciary from exercising its discretion such that its compensation could vary based on the advice given or securities recommended. Absent the exemptions discussed below, advisors would be precluded from receiving third party payments, commissions or other variable remuneration and payments related to products purchased by their retail retirement clients.
• One exemption involves financial institutions that serve as principal in the purchase or sale of securities (such as bonds or CDs) to clients, but the key exemption is the Best Interest Contract Exemption (“BICE”). BICE allows financial institutions and advisors to retail retirement clients to receive forms of compensation that would otherwise be prohibited, such as commissions and revenue sharing payments, subject to compliance with a number of conditions.
• Broadly, BICE allows advisors and institutions to receive otherwise prohibited forms of compensation (commissions) resulting from recommendations to a retail retirement customer as long as:
  • The institution or advisor adheres to Impartial Conduct Standards (“ICS”) (below);
  • It adopts and complies with policies and procedures designed to ensure compliance with the ICS; and
  • It complies with certain recordkeeping and disclosure requirements.
• BICE applies differently to IRAs than it does to qualified ERISA plans and includes different procedural requirements for new clients than for clients with an existing investment advisory agreement covering their IRA:
  • The new client and the institution must enter into an enforceable contract prior to or at the time of the first recommended transaction, in which the institution:
    • Acknowledges it is a fiduciary;
    • Agrees to adhere to the ICS;
    • Warrants adoption of and compliance with, anti-conflict policies and procedures; and
    • Provides the required disclosures as to fees and conflicts of interest.
  • The contract cannot include provisions disclaiming or limiting the liability of the institution or the client waiving its right to bring a court action or bind itself to arbitration.
  • The institution must comply with recordkeeping requirements and must notify the DoL of its intention to rely on the BICE before receiving any compensation.
  • These same provisions apply to existing IRA clients, except that a separate BICE contract need not be physically signed. A “negative consent procedure” is permitted, with the institution delivering a revised contract with the required provisions and if the client does not terminate the contract within thirty days, it is considered effective.
• ERISA qualified plan clients do not require a separate BICE contract, but the other requirements still apply.
• Generally, an advisor will not be required to rely on BICE when its fees are level, because it exercises no discretion over fee income. If an advisor recommends a participant roll money out of an ERISA plan into an IRA that will bear ongoing fees (even if level), requires disclosures and compliance with ICS standards.
• Adherence to ICS means that:
  • The advisor will provide investment advice that is the Best Interest of the client;
  • The compensation is not in excess of what ERISA defines as reasonable; and
  • The advisor does not make materially misleading statements regarding the recommended transaction, fees or material conflicts of interest.

We have discussed the new Fiduciary definitions and requirements for investment advisors to qualified ERISA plans and IRAs and we have now discussed the exemptions from the new requirements and how to satisfy them. What does this mean to the public retirement plan client?

• The Fiduciary Rule drastically extends the scope of ERISA to vast segments of the retirement market that did not exist at the time of ERISA’s adoption.
• The SEC recently announced that it will adopt a fiduciary rule applicable to all clients of registered investment advisors, prior to April 2017.
• Hopefully this is the first step, albeit by the DoL, in lieu of Congress or the SEC, that opens the duty of care of investment advisors to public scrutiny. For too many years the federal government has listened to the lobbyists of big Wall Street firms and their limitless campaign financial support.
• Remember that the White House estimated that the new Fiduciary Rule will result in a $76 billion gain in retirement plans over the next 20 years. The fairness sought in this rule is of HUGE value to today’s retirement investor.
• When it comes to an issue as important as our retirement system, proactive governance is necessary and to be celebrated. Those retiring over the next 20 years are entitled to a fair system.

We will expand our retirement plan discussions next submission.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

Having hopefully piqued everyone’s interest with scary statistics last time, let us proceed to consider the U.S. Department of Labor’s (DoL’s) new Fiduciary rule and its potentially broad impact on society. Nearly one-third of U.S. Households owned individual retirement accounts (IRAs) in 2015, with approximately $7.3 Trillion in assets. Some 59% of those with rollover IRAs worked with a financial advisor in choosing investments. [Investment Company Institute data].

• Retirement plans are jointly regulated by the DoL and the Internal Revenue Service (“IRS”) pursuant to the Employee Retirement Security Act of 1974 (“ERISA”) and the Internal Revenue of 1986 (“IRC”).
• Qualified plans are regulated by ERISA and IRAs are governed by the IRC.
• The DoL Fiduciary rules redefine fiduciary to include any advisor giving investment advice to a plan or its participants and beneficiaries (under ERISA) or IRAs (under the IRC); Fiduciary is the legal term for putting clients’ interests first.
• The DoL also finalized exemptions to the prohibited activity sections of ERISA and the IRC, including the Best Interest Contract Exemption, which permit fiduciaries to receive fees in certain circumstances.
• The Rule is the first and only amendment to the definition of “Fiduciary” under ERISA in forty (40) years, expanding beyond qualified plans to IRAs.
• The Rule was proposed one year ago and received many comments from interested parties, many of which were reflected in the final rule.
• The DoL wanted to ensure that retirement investors receive advice that is in their best interest, with particular concern for the impact of conflicted advice on the retirement assets of retail investors.

The Rule imposes fiduciary duties on advisors who recommend investments to:

• Qualified plans, plan fiduciaries, participants and beneficiaries
• IRAs and IRA fiduciaries

An advisor is deemed to have given investment advice under ERISA if:

• It represents it is acting as a fiduciary under ERISA or the IRC;
• It renders advice pursuant to an agreement where advice is based on a recipient’s individual circumstances; or
• It makes a recommendation as to any particular investment, strategy or similar activity, directed to a specific recipient of the advice.

The Rule specifically makes an advisor’s investment recommendations to rollover assets from a qualified plan or IRA fiduciary in nature. Public speeches, advertisements, investment education, appraisals, fairness opinions and valuations are not deemed investment advice.

This Fiduciary rule marks a radical shift for brokers and broker-dealer firms, who will no longer be judged by a suitability standard but instead, owe a higher, fiduciary duty to put their clients’ interests first. The rule prohibits commission-based fee arrangements and other forms of conflicted compensation common in the brokerage industry. Investment advisors cannot accept compensation or payments that would create a conflict unless they qualify for an exemption that ensures the client is protected. An investment advisor who makes an investment recommendation and receives conflicted compensation in connection with the advice provided to the plan or IRA will engage in a prohibited transaction unless one of the enumerated carve-outs from the rule applies or the advisor complies with the “Best Interest Contract Exemption” (“BICE”) requirement. To keep the reader on the edge of his/her seat, we will address the specifics of the prohibited transaction exemptions and BICE, together with the broader potential impact of the Fiduciary rule, in the next submission.

The Fiduciary rule is effective on June 7, 2016, but is implemented in phases:

• The expanded definition of “fiduciary” will not apply until April 10, 2017.
• Compliance with the various provisions of BICE transition in phases between April 10, 2017 and January 1, 2018.

The House passed a resolution blocking effectiveness of the Fiduciary rule on April 28, 2016, with less than a veto-proof majority, and the Senate is considering such a measure. President Obama has vowed to veto any such legislation hitting his desk.

Remember, it’s not what you make that matters…it’s what you keep!

Disclaimer
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.