1. WORRYING ABOUT INFLATION’S EFFECT ON YOUR PENSION FINANCES? DON’T.:
Inflation can affect Defined Benefit (DB) plan finances, but the latest bout of it seems mostly favorable for plan sponsors, retirement industry experts say.
Brian Donohue, a partner at October Three Consulting, says that for inactive participants--or, for frozen plans, all participants--DB liabilities are fixed-dollar liabilities, so if inflation is high, the “real” value of their future pension payments declines. This decreases the purchasing power of the benefits participants eventually receive, but it makes the cost of liabilities less expensive for plan sponsors.
“It’s worth noting that, for most of this century, inflation has been very low, which is part of the reason pensions have been much more expensive to employers (and much more valuable to employees) than we would have guessed 20 years ago,” Donohue says.
Donohue notes that inflation has been less than 2% for the past two years on average, which is lower than expected.
“Everyone thinks inflation is bad, but part of the pain plan sponsors have suffered is because inflation has been lower than expected,” he explains. “They made benefit promises thinking that inflation would be higher, but, since it was not, it has been more expensive to cover those promises.” He adds that for sponsors of frozen DB plans, with fixed benefit liabilities, inflation would help them more than hurt.
Kevin McLaughlin, head of liability risk management, North America, at Insight Investment, says that with corporate DB plans, the majority of future liabilities are nominal, so there is no link with inflation. He notes that inflation could affect employee wages, however, which would affect benefit accruals.
For public DB plans, many offer cost-of-living adjustments (COLAs), and inflation would increase those payments. McLaughlin says this could be a bad thing if public plan assets were unable to keep up with inflation risk. “Many public pension plans are underfunded, so anything that increases liabilities but not assets is problematic,” he says.
How Inflation Affects DB Plan Investing
On the DB plan asset side, higher inflation means higher interest rates, which is bad news for fixed-income investments, McLaughlin says. But corporate DB plans use fixed-income investments to match liabilities, so inflation will lower both fixed-income assets and liabilities.
However, inflation would not change the long duration fixed-income investments held in corporate DB plans.
“Corporate plans should keep hedges in place,” McLaughlin says. “If interest rates were to rise, it would mean corporate pensions will be better funded. The average hedge ratio is around 50%, so better funding means [pensions] could buy more liability matching, long duration fixed income.”
Donohue explains, “One way to think about hedging liabilities is that you’re out of the game and don’t really care about inflation or interest rates. If inflation is sustained, and your only goal is to stabilize pension finances and you’re invested in duration-matching bonds, what will happen is the value of bonds will go down and the value of liabilities will go down correspondingly.”
In the public sector, liability hedging is not as common, McLaughlin notes. He says public plans hold fixed income for diversification, and he would expect public plan sponsors that are worried about inflation’s effect on fixed income to keep the duration of their investments short.
McLaughlin says whether inflation is good or bad for equity investments depends on what is causing it: a demand hold or a cost push.
“The bad scenario for equities would be if there is an increase in cost but businesses can’t pass that on to customers,” he explains. “If costs rise faster than revenue, profits will decline. Higher inflation means lower multiples of future earnings.”
The impact of inflation is less clear for equity investments than for bonds or fixed-income investments, Donohue says. Some industries will benefit and others will be hurt. He says DB plan sponsors can trust their investment managers to watch the market and adjust equity investments accordingly.
Inflation doesn’t uniformly affect industries, Donohue notes. Bonds are a lot more homogeneous than stocks, so inflation overall is not a great thing because it makes managing equities more complex. However, he notes that most companies can handle modest inflation. “In the ’90s, we saw inflation of about 3% a year, but no one was talking about it,” he says.
McLaughlin says he believes the economy is seeing a more benign scenario now. “Although costs are increasing, companies have pricing power and can pass that on to customers,” he says. “It’s not true in all sectors, but generally speaking it is.”
Over a very long run, higher inflation will mean higher equity prices in general, McLaughlin adds. But, he says, Insight Investment’s view is that the inflation happening now is a temporary fluctuation caused by transitory changes.
“We still think inflation is contained over the long term,” he says. “The reason inflation risk is high is we are just reopening post-COVID-19, and there is stress in the supply chain. Inflation had declined a year ago because of COVID, but now it’s catching up.”
McLaughlin says that because Insight Investment is skeptical this is a long-term inflation trend, it is advising DB plan sponsor clients to stay the course for asset allocation purposes, although the firm understands why plan sponsors may have concerns.
“I do think that if plans are under-allocated to real assets and inflation-linked assets, they can look to allocate more to them as a hedge or diversifier,” he says. “They should look into government bonds that allocate to TIPS [Treasury inflation-protected securities], and if they have active equity managers, they can work with them to tilt portfolios toward firms with good pricing power, which generally won’t be adversely affected by inflation.”
“We’ve just had a little blip of inflation and if that’s all it is, in all likelihood it will have no effect on long-term interest rates,” Donohue says. “If we have a long run of inflation, the people in the business of lending money will decide they need to charge more, and ultimately that would change the rate used to measure pension liabilities.” Rebecca Moore, PLANSPONSOR, www.plansponsor.com, June 1, 2021.
2. GENERATIONS RESPOND DIFFERENTLY TO RETIREMENT SAVINGS:
A new study by BlackRock finds various demographic groups hold different attitudes on their retirement savings, with many admitting to numerous anxieties.
Research from BlackRock’s 2021 “DC Pulse Survey” found that the coronavirus pandemic may have exacerbated concerns for plan participants who were already behind on their savings.
Covering more than 1,000 participants and 225 large defined contribution (DC) plan sponsors, the study found that 52% of plan sponsors kept track of short-term 401(k) loan withdrawals. Those that kept track said employees spent their 401(k) savings on emergency spending needs throughout 2020. Other effects of the pandemic, including furloughs and suspensions of company matches, devastated retirement savings for some--61% of employers noted that at least half of their employees were negatively affected in terms of retirement readiness. Fifty-two percent say more participants withdrew or borrowed from their retirement savings plan than normal due to COVID-19.
The study added that 68% of DC plan participants reported feeling like they were on track with their retirement savings in 2021; however, 47% of participants overall say the pandemic has had some adverse effect on their retirement savings.
This is especially true for members of younger generations, who believe they will not be able to enjoy the same quality of retirement as Baby Boomers and the Silent Generation, which includes people born between 1928 and 1945. The study found 76% of Millennials and 68% of Generation Xers agree that people in their generation will not have the level of retirement income that retirees used to own. Amid the skepticism over their savings, Millennials are looking at owning retirement income solutions instead, as 94% reported expressing interest in annuities.
Gen Xers were most likely to say they are unsure if they are on track with their retirement savings, with 25% revealing they are unsure and another 13% saying they are not on track. They cited the rising cost of living, not saving enough and other expenses as their top concerns.
Financial insecurity has overwhelmed Gen Xers since before the pandemic. Also known as the “sandwich generation” for the financial squeeze that simultaneously caring for parents and children has put on them, this group of workers often juggles child care, elder care and mortgages with their careers and saving for a post-career life. For many, the pandemic had knocked over any stability that grounded their financial wellness, experts say.
Women are also facing ongoing turmoil, with 64% saying they are worried about outliving their retirement savings, compared with 55% of men. Additionally, while over half (59%) believe they are on track for retirement, this is overshadowed by 78% of men who believe the same. Eighty-four percent of women also prefer to save more now to ensure they won’t have to scale back in retirement, the study reports.
To do so, more female participants are searching for financial advisers to address their concerns, especially when it comes to managing their investments. Forty-nine percent of women say they do not know enough to manage their own investments, while 36% are not aware of target-date funds (TDFs). Instead, 50% of women reported preferring to use a professional to manage their plan. Amanda Umpierrez, planadviser, www.planadviser.com, June 7, 2021.
3. 2021 UPDATE; PUBLIC PLAN FUNDING IMPROVES AS WORKFORCE DECLINES:
The brief’s key findings are:
- The aggregate funded ratio improved from 73 to 75 percent from FY 2020 to 2021. At the same time, contribution rates rose from 21 to 22 percent of payrolls.
- While initial expectations for public pensions were low due to COVID, financial markets rebounded and municipal tax revenues were quite resilient.
- Yet one other COVID-related factor – cuts to the state and local workforce – impacted public pension finances in FY 2021.
- These cuts had little impact on funded status and required contribution amounts, but they do explain the rise in contribution rates, which are expressed as a share of lower payrolls.
This brief is available here. Jean-Pierre Aubry and Kevin Wandrei, Center for Retirement Research, SLP#78, https://crr.bc.edu, June 2021.
4. APRIL’S DISPOSABLE INCOME DROPPED AS GOVERNMENT PAYMENTS FALL:
Disposable personal income fell to $18.8 trillion in April from March's $22.1 trillion, primarily driven by reduced government payments, particularly unemployment benefits and pandemic assistance. April saw spending edge up to $16 trillion from the prior month's $15.9 trillion.
Employee compensation, representing about 60% of personal income, has risen steadily each month for the last year. This includes increasing to $12.3 trillion in April from March's $12.2 trillion. This will need to continue increasing as government transfer payments recede, barring additional action. April's transfer payments were $4.8 trillion, down from $8.2 trillion in March. Other payments, which includes the special pandemic payments, were $1.4 trillion compared to $4.7 trillion. In April, unemployment compensation totaled $495.4 billion vs. March's $541.2 billion.
Larry Rothman, Pension & Investments, www.pionline.com, June 3, 2021.
5. MORTGAGE BORROWERS’ CREDIT SCORES RISE TO NEW RECORD HIGH:
Americans with near-perfect credit scores are reaping the rewards of record-low mortgage rates, a trend that underscores the economic divide created by the coronavirus recession.
The typical credit score for mortgage borrowers rose to 788 in the first quarter, a record high, the Federal Reserve Bank of New York said in a quarterly report. That’s the highest level in at least two decades. During the era of loose lending that led to the Great Recession, the median credit score of mortgage borrowers fell as low as 707.
Meanwhile, only a quarter of borrowers who landed home loans during the January-through-March period had credit scores of less than 742. Just 10% had credit scores below 688, according to the New York Fed’s data.
The numbers have been skewed upward in part by the large share of mortgage refinancings in 2020 and 2021. People who already own homes generally have higher credit scores than first-time buyers.
What’s more, mortgage lenders grew more risk-averse during the coronavirus pandemic. In the early months of the recession, mortgage brokers described being required to complete near-obsessive verifications of borrowers’ employment and incomes.
A symptom of the K-shaped recovery
Americans’ fortunes have diverged widely during this recession. Those who can work remotely have continued to collect paychecks. Home prices have soared, and stocks have recovered the value they lost earlier in the year.
However, lower-wage workers struggle as restaurants, hotels and other service-sector employers continue to be battered by the pandemic. Economists have invoked the K-shaped recovery to describe the disconnect -- affluent Americans’ fortunes are rising like the top half of the letter, while the working classes are experiencing the downward slope of the bottom half of the K.
“A symptom of the K-shaped consumer recovery is that those on steady financial footing or with higher incomes are able to buy a home or refinance the mortgage on an existing home,” says Greg McBride, CFA, Bankrate chief financial analyst. “The pool of borrowers in 2020 seems to increasingly come from the upper leg of the K.”
The highest possible credit score in the FICO system is 850. A score higher than 740 is considered excellent.
“A FICO score is not an indication of wealth,” says radio host and author Chris Hogan, a personal finance expert. “It’s more of an indication of how you’ve dealt with debt.”
Rising scores come with an upside for both lenders and borrowers: A homeowner with a credit score approaching 800 is exceedingly unlikely to default. For borrowers, that means little risk of a financially devastating foreclosure.
“If you sign on to buy a home before you’re ready, it can be more of a curse than a blessing,” Mr. Hogan says.
What you can do
Your credit score is the single most important factor in determining your mortgage rate. Here’s how you can boost it -- and what to do if your score won’t go any higher:
Pay down credit card debt: If you have a choice between tackling debt or scraping together a larger down payment, it’s wiser to focus on the debt because that should improve your credit score.
Pay monthly bills on time: Payment history plays the biggest part in your credit score. To keep from forgetting to write a check, automate your routine payments. To avoid a missed payment, build your emergency savings.
Consider an FHA or VA loan: Compared to conforming loans backed by Fannie Mae and Freddie Mac, mortgages backed by the Federal Housing Administration and the U.S. Department of Veterans Affairs carry less stringent rules about credit scores. However, the upfront fees are higher. Know when enough is enough: The best mortgage deals go to borrowers with scores above 740, but improvements beyond that point won’t do much to affect your rate. Keep an eye on your score, of course, but understand that boosting it from 790 to 800 won’t get you a better deal. Jeff Ostrowski, www.bankrate.com, June 5, 2021.
6. HERE’S HOW TAXPAYERS CAN PAY THE RIGHT AMOUNT OF TAX THROUGHOUT THE YEAR:
Federal taxes are pay-as-you-go. This means that people need to pay most of their tax during the year, as they earn income. This can be done either through withholding or estimated tax payments.
If the amount of income tax withheld from a taxpayer’s salary or pension is not enough, or they receive income such as interest, dividends, alimony, self-employment income, capital gains, prizes and awards, they may need to make estimated tax payments. Self-employed taxpayers may also need to make estimated tax payments.
Adjust 2021 withholding
All taxpayers should review their federal withholding each year to make sure they're not having too little or too much tax withheld.
Employees, retirees and self-employed individuals can use the IRS Tax Withholding Estimator to help decide if they should make a change to their withholding. This online tool guides users, step-by-step through the process of checking their withholding, and provides withholding recommendations to help aim for their desired refund amount when they file next year. Taxpayers can check with their employer to update their withholding or submit a new Form W-4, Employee's Withholding Certificate.
Make 2021 estimated tax payments
Estimated payments are another way for taxpayers to pay what they owe in separate quarterly payments. For tax year 2021, remaining quarterly estimated tax payments are due from individual taxpayers on June 15 and September 15, 2021, and January 15, 2022. The fastest and easiest way to make estimated tax payments is electronically using Direct Pay or Electronic Federal Tax Payment System. Taxpayers can visit IRS.gov for other payment options.
Pay as You Go, So You Won't Owe
Form W-4S, Request for Federal Income Tax Withholding from Sick Pay
Form W-4V, Voluntary Withholding Request
Share this tip on social media -- #IRSTaxTip:Here’s how taxpayers can pay the right amount of tax throughout the year. https://go.usa.gov/x6bcT. IRS Tax Tip 2021-81, www.irs.gov, June 8, 2021.
7. MORE MONEY IS COMING TO FAMILIES…AND SCAMMERS ARE READY:
As part of the American Rescue Plan Act, eligible families will get monthly payments from the government from July 15 through December 2021. The Internal Revenue Service (IRS) will send these monthly payments directly to people through direct deposit, paper checks, or debit cards. Unlike economic impact payments, these payments are an advance on families’ child tax credit. People who are eligible will get up to half of their child tax credit in these monthly payments and the other half when they file their 2021 taxes.
If you qualify for payments -- which depends, in part, on how much you make -- you’ll get them on about the 15th of each month, automatically, without having to do anything. The IRS is working to get online systems set up on its webpage and make sure all questions get answered. Go to IRS.gov for the latest info on who qualifies, how much you’ll get, and how to address any problems you might run into.
When money from the government is in the news, we know scammers are about to run their standard playbook. They may call, email, text, or DM you. They’ll say they can help you get your payments earlier (they can’t), get you more money (also no), or tell you other lies (for sure). Here’s the real deal:
- Only the IRS will be sending these payments. Anyone trying to “help” you get your child tax credit is really after your money.
- The government will NEVER call, text, email, or DM you out of the blue, asking for money or information. Keep your money -- and your Social Security, bank account, debit and credit card numbers -- to yourself.
- Nobody legit will ever demand that you pay by gift card, wire transfer through companies like Money Gram or Western Union, or cryptocurrency. That’s a scam, every time.
If someone tries to scam you out of these payments or anything else, report it to the FTC at ReportFraud.ftc.gov. Lisa Lake, Consumer Education Specialist, FTC, www.ftc.gov, June 2, 2021.
8. NORTH CAROLINA CITY STOPS RESPONDING TO NON-EMERGENCY CALLS DUE TO ‘STAFFING CRISIS’:
A quirky North Carolina city is going to have to call someone else for non-emergency calls, because the Asheville Police aren’t coming.
Asheville, a left-leaning progressive bastion town on the outskirts of the state’s traditionally conservative high country, is facing an officer shortage, which has been dubbed a “staffing crisis.”
“The Asheville Police Department (APD) has lost 84 officers since January 1, 2020,” the agency posted to Facebook. “As a result of the staffing crisis, several changes in officer response will go into effect immediately in order to improve response times for emergency calls made to 9-1-1.”
According to Fox News, APD officers will no longer respond in-person to 911 calls involving incidents where suspect information is not available; harassing phone calls that don’t include threats to life, identity theft, trespassing reports that don’t involve pressing charges, and others.
From the start of 2020, 84 of the 238 sworn officers available in 2019 have left the agency.
Asheville was the site of several activist protests in 2020. Leo Affairs, https://leoaffairs.com, June 7, 2021.
9. FOR THOSE WHO LOVE WORDS:
"Ocean" vs. "Sea"; What's The Difference? Click here to find out.
10. QUOTE OF THE WEEK:
“If you think you are too small to make a difference, try sleeping with a mosquito.” -Dalai Lama
11. TODAY IN HISTORY:
On this day in 1845, at Andrew Jackson's African Grey parrot "Poll" is removed from his funeral for swearing at The Hermitage, Tennessee. Funeral attendee William Menefee Norment recorded: "Before the sermon and while the crowd was gathering, a wicked parrot that was a household pet got excited and commenced swearing so loud and long as to disturb the people and had to be carried from the house”.
12. REMEMBER, YOU CAN NEVER OUTLIVE YOUR DEFINED RETIREMENT BENEFIT.