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Cypen & Cypen
FEBRUARY 24, 2011

Stephen H. Cypen, Esq., Editor

1.      401(K) PLANS FALL SHORT: says the 401(k) generation is beginning to retire, and it is not a pretty sight.  Retirement savings plans that many baby boomers thought would see them through old age are falling short in many cases.  The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain the standard of living in retirement. Even counting Social Security and any pensions or other savings, most 401(k) participants appear to have insufficient savings.  Data from other sources also show big gaps between savings and what people need, and the financial crisis has made things worse.  The analysis uses estimates of 401(k) balances from the end of 2010 and of salaries from 2009.  It assumes people need 85% of their working income after they retire in order to maintain their standard of living, a common yardstick. Facing shortfalls, many people are postponing retirement, moving to cheaper housing, buying less-expensive food, cutting back on travel, taking bigger risks with their investments and making other sacrifices they never imagined. The problems are widespread, especially among middle-income earners.  About 60% of households nearing retirement age have 401(k)-type accounts which represent the majority of most people's savings.  The situation is less dire for those in a higher income bracket, who tend to save more outside their 401(k) accounts and who have more margin for error if their retirement returns fall below the recommended 85% figure. Initially envisioned as a way for management-level people to put aside extra retirement money, the 401(k) was embraced by big companies in the 1980s as a replacement for costly pension funds.  Suddenly, they were able to transfer the burden of funding employees' retirement to the employees themselves. (Bingo.) Remember the expression “follow the money?” Well these 401(k) accounts were a gold mine for money-management firms.  In 30 years, the 401(k) went from a small program to a multi-trillion-dollar industry supporting thousands of financial planners and money managers.  But a 401(k) also requires steady, significant savings.  And unlike corporate pension plans, which are guaranteed by an agency of the government, 401(k) plans have no such backstop. The government and employers are not going to pay more for people's retirements.  Unless people begin saving earlier and contributing more to their 401(k) plans, they are destined to hit retirement age with too little money. 

2.      SIX PROBLEMS WITH 401(K) PLANS:    And speaking of 401(k) plans, recently published an article outlining six problems with 401(k) plans. Over the past quarter of a century, 401(k) plans have evolved into the dominant retirement plan scheme for most U.S. workers. While improvements have been made to the structure and features of 401(k) plans since their creation, additional problems still need to be addressed, and various enhancements still need to be made.  Here are six problems with the current 401(k) plan structure and how some negative implications can be mitigated: 

  • Structural Flaws Associated with Investing Contributions. You have probably been told that investing your money through a process known as dollar-cost-averaging will allow you prudently to build your retirement nest egg over time. Unfortunately, while this concept may be true when the market is expected to trend up over time, it is not true when the market is oscillating in a relatively flat manner, and it is not true if the market is trending down.  Therefore, while it may make sense for you to buy more and more shares of an asset that is increasing in value, this philosophy does not make sense if you are buying an asset that is fully valued or one that is decreasing in value. Fortunately, you can take control of your investment process by directing all of your retirement plan contributions into a conservative investment option.  Then, when the time is right, you can make a strategic investment allocation of the cash that you have accumulated to one or more of the other available funds.  
  • Long Investment Time Horizons Have Negative Investment Implications. You also probably have been told that your employer established a 401(k) plan on your behalf in order to provide you with a long-term savings plan for retirement.  Given this premise, you were most likely led to believe that you should develop a long-term strategic asset allocation based on a time horizon that is likely to exceed a decade.  Unfortunately, what you may not have been told is that it is highly unlikely that the portfolio managers currently managing your investment options will be managing them 10 or more years from now.  First, you can develop a tactical asset allocation contingency plan, which will allow you to be prepared to take action in the event one of your portfolio managers relinquishes responsibility.  Second, you could open a traditional IRA or Roth IRA, and contribute up to your legal limit through various types of index fund strategies not available in your 401(k) plan.  
  • Administrative Costs Have a Detrimental Impact on Future Retirement Savings.  Make no doubt about it, a qualified 410(k) plan is an expensive employee benefit. It is expensive to offer because there are many compliance issues that have to be monitored, there are many ongoing service and administration functions that have to be provided and there is a host of education and communication services required to be offered.  Given these requirements, it is highly likely that you are paying through participant fees, supplemental asset based charges, itemized costs for services such as loans, hardship withdrawals and qualified domestic relations orders, and perhaps more importantly, higher fund expenses.  Fortunately, you can mitigate negative costs of your 401(k) plan by developing a tailored retirement plan strategy.  To accomplish this goal, you should always invest in your 401(k) plan up to the point where you receive 100% of your employer's matching contribution.  Then, you should open a traditional IRA or Roth IRA, and contribute up to the legal limit.  After you have maxed out the money you can contribute to an IRA, you should then increase your contribution rate in your 401(k) in order to reach your desired level of savings.  
  • Lackluster Recordkeeping Mitigates Accurate Financial Planning Assessments. You probably do not understand the complexities associated with recordkeeping the assets that you have accumulated in your 401(k) plan.  Ironically, even in today's age of technology, recordkeeping is still a labor intensive endeavor, particularly if your records have to be generated for many years.  Nevertheless, if this type of information is not compiled, it will be virtually impossible for you to determine if you are on track in terms of meeting your long-term financial goals.  Therefore, to address this problem, it is recommended that you review the Global Investment Performance Standards ( to learn how to complete this important endeavor.  
  • Sub-Par Investment Plan Designs and Marginal Quality Investment Options Impair Results. In terms of retirement plan design, the conventional wisdom in the 401(k) plan investment industry is that "less is more,” which means that a comprehensive retirement plan design can be developed by offering a host of investment options that cover roughly five asset class categories. In terms of theoretical risk order, the categories are money market/stable value funds, core bond funds, large capitalization funds, small capitalization funds and international funds.  Unfortunately, while you can develop a diversified portfolio by investing in funds that fall in these five asset class categories, it is highly likely you will also need access to TIPS funds, high yield funds, REIT funds, mid-capitalization equity funds, emerging markets funds and commodity funds in order to build a comprehensive portfolio capable of meeting your long-term financial needs. Thus, you should assess how comprehensive your 401(k) retirement plan design is, and conduct a thorough due diligence analysis on the funds that are offered in your plan, before making any type of investment.  Once this assessment has been completed, your best course of action will be to notify your human resources department of any enhancements that need to be made.  (Lots of luck here.) 
  • Tax Implications are Complex, Uncertain and Ever-Changing. Arguably the most highly touted 401(k) plan attribute is the pre-tax treatment of invested cash flows.  This feature is important, because if you have more money to invest up front, you should have a greater opportunity to enhance your returns down the road.  However, before blindly accepting the premise that pre-tax investing is a big investment advantage for you, keep in mind that when you withdraw your money from your 401(k) plan, the entire amount that is withdrawn will be taxed at your personal income tax level.  So, what looks like a good deal today may very well be a bad deal tomorrow. Given all of the uncertainties associated with taxes, you probably should not base your decision to contribute to your 401(K) plan by taking into account any type of perceived tax benefits. 

In conclusion, while 401(k) plans are an important part of your employee benefits package, the issues associated with some of their provisions are very problematic.  Nevertheless, if you pay close attention to the issues discussed, and take an active role in preparing for your financial future, you may be able to mitigate the negative features of your 401(k) plan, and navigate your way in a manner that will allow you to meet your retirement plan goals. (And we add a big “NOT.”) 

3.      CALIFORNIA TREASURER SAYS STUDY GIVES BAD ADVICE ON STATE PENSIONS:   Writing a commentary for, California’s State Treasurer Bill Lockyer says his  help led efforts to curb public pension corruption, fight abusive benefits, reduce payouts and control liabilities.  He is committed to completing the additional work that needs to be done, but reforms need to be based on sound accounting and real evidence. Lockyer recently called last year's Stanford report on California public pensions' unfunded liabilities a "piece of crap."  The Stanford student- authors acted at the direction of former Gov. Arnold Schwarzenegger, who opposed defined-benefit pensions. The reports grossly overstate public pensions' unfunded liabilities.  The reports have fueled hysteria about pension costs pushing governments to the brink of insolvency and default.  And they have been exploited by politicians who despise public employee unions and their defined-benefit plans, and want to entrust families' retirement security to Wall Street's good graces.  They are dogma-inspired "studies," wearing academic perfume, used to further political vendettas. To calculate their defined benefit pension liabilities, corporations use a discount rate of return tied to yields on investment-grade bonds.  Using accepted accounting standards, California Public Employees Retirement System and other public pensions use the expected return on their investment portfolio.  Applying the corporate model to public pensions would make no sense, cost taxpayers a bundle and destabilize government budgets.  The Stanford students ignore these problems to satisfy their political sponsor.  They even go beyond the corporate norm, and say the state's retirement funds should use an unprecedented "risk-free" rate tied to low-yielding U.S. Treasuries.  The specific rate the study used was 4.14 percent.  In contrast, CalPERS' expected return is 7.75 percent.  The lower the number, the higher the unfunded liability.  Using CalPERS' rate, its unfunded liability was $35 Billion. Stanford's risk-free rate ballooned the unfunded liability to a ludicrous $240 Billion. CalPERS' 7.75 percent rate has worked because it is conservative and prudent.  Over the past 21 years, CalPERS' portfolio has generated an average annual return of 8.6 percent.  In 15 of those years, it beat the 7.75 percent assumed return rate. Neither corporate nor public pensions invest their entire portfolios in Treasuries or bonds.  They diversify to earn better returns, but it makes some sense for corporations to use a steeper discount in setting liabilities.  Companies can disappear overnight.  People need to know their pension liability if they suddenly go belly-up, and have to terminate their plan.  Corporations need to account for that scenario.  Governments do not vanish.  They need to figure out how to fund the plan over the long haul, not estimate its termination price.  This issue is crucial for anyone who cares about taxpayers and fiscal stability.  The risk-free requirement hurts both. Artificially deflating expected returns and artificially inflating underfunded liabilities require taxpayers unnecessarily to contribute much more. The risk-free approach would also inject substantial volatility into the plans' funded status, by tying liabilities to interest rates.  That volatility would infect the state's contribution amounts, and, thus, its budget.  From 1989 to 2005, corporate contributions to defined benefit plans rose or fell by 15 percent or more in nine of 17 years, including three years when the change exceeded 50 percent.   On the other hand, government contributions to public defined benefit plans varied by 15 percent or more in just three of 17 years.  Clearly, the approach used by CalPERS and other public pensions is better because it smoothes and stabilizes taxpayers' costs. Bravo, 

4.      SAN FRANCISCO MAY “LOSE” 500 POLICE OFFICERS:   Police officers may leave San Francisco Police Department due to budget considerations. At issue is the Deferred Retirement Option Program, approved by San Francisco voters and designed to keep veteran officers on the force. Once an officer reaches 25 years of service and is over the age of 50, the officer can opt for DROP. The police officers retire, but their pension is paid into a special savings account until they terminate employment, after which their pension is paid to them and they receive the balance in the DROP account. DROP will be voted upon by the City Board of Supervisors in April, and if it is discontinued, the clock will start ticking on mass retirements:  the force has 490 officers with 25 years of service or more. (There are 370 with 30 years or more.) In other words, within three years the City could lose 500 police officers -- in addition to those who retire without going into DROP. There is a minor complication: there are no police academy classes in 2011 and 2012.  Oops! It may be time to bring back Karl Malden and Michael Douglas. 

5.      REMARKABLE QUOTES FROM REMARKABLE JEWS: I went on a diet, swore off drinking and heavy eating, and in fourteen days I had lost exactly two weeks.   Joe E. Lewis

6.      BLESSED ARE THE CRACKED, FOR THEY LET IN THE LIGHT:  Stupidity is not a handicap. Park elsewhere! 

7.      PARAPROSDOKIAN: (A paraprosdokian is a figure of speech in which the latter part of a sentence or phrase is surprising or unexpected in a way that causes the reader or listener to reframe or reinterpret the first part. It is frequently used for humorous or dramatic effect.):   Going to church doesn't make you a Christian any more than standing in a garage makes you a car. 

8.      QUOTE OF THE WEEK:    “Men govern nothing with more difficulty than their tongues.” Spinoza

9.      KEEP THOSE CARDS AND LETTERS COMING: Several readers regularly supply us with suggestions or tips for newsletter items? Please feel free to send us or point us to matters you think would be of interest to our readers. Subject to editorial discretion, we may print them. Rest assured that we will not publish any names as referring sources. 

10.    PLEASE SHARE OUR NEWSLETTER: Our newsletter readership is not limited to the number of people who choose to enter a free subscription. Many pension board administrators provide hard copies in their meeting agenda. Other administrators forward the newsletter electronically to trustees. In any event, please tell those you feel may be interested that they can subscribe to their own free copy of the newsletter at Thank you. 

Copyright, 1996-2011, all rights reserved.

Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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