1. RETIREMENT ASSETS DROPPED 12% IN FIRST QUARTER 2020:
Data from the Investment Company Institute (ICI) reveals that retirement assets across the board took a hit in the first quarter, but it could have been worse.
DC plan assets were down 12.3% from the beginning of the year, dropping to $7.9 trillion for all employer-based DC retirement plans as of March 31, 2020, according to the ICI’s “The U.S. Retirement Market, First Quarter 2020.” Of this amount, $5.6 trillion was held in 401(k) plans.
Besides 401(k) plans, the first quarter data show that $490 billion was held in other private-sector DC plans, $988 billion in 403(b) plans, $305 billion in 457 plans and $580 billion in the Federal Employees Retirement System’s Thrift Savings Plan (TSP).
Mutual funds managed $3.3 trillion or nearly 60% of assets held in 401(k) plans at the end of March 2020. Equity funds, not surprisingly, were the most common type of funds held in 401(k) plans with $1.8 trillion, followed by $939 billion in hybrid funds, which include target date funds.
Overall, ICI notes, total U.S. retirement assets were $28.7 trillion as of March 31, 2020, down 11.9% from the beginning of the year. Retirement assets accounted for 33% of all household financial assets in the U.S. at the end of March 2020.
Private-sector DB plans held $3.2 trillion in assets at the end of the first quarter of 2020, while annuity reserves outside of retirement accounts accounted for another $2.2 trillion.
Total U.S. retirement entitlements, as of March 31, 2020, were $35.7 trillion, including $28.7 trillion of retirement assets and another $6.9 trillion of unfunded liabilities, the ICI notes. Including both retirement assets and unfunded liabilities, “retirement entitlements” accounted for 41% of the financial assets of all U.S. households at the end of March.
Under the ICI’s estimates, retirement entitlements include both retirement assets and the unfunded liabilities of DB plans. The organization notes that unfunded liabilities are a larger issue for governmental DB plans than for private-sector DB plans. As of the end of the first quarter, unfunded liabilities were 11% of private-sector DB plan entitlements, 55% of state and local government DB plan entitlements and 46% of federal DB plan entitlements.
Meanwhile, assets in IRAs totaled $9.5 trillion at the end of the first quarter, which was a decrease of 13.7% from the end of the fourth quarter of 2019, the ICI notes. Forty-three percent of IRA assets, or $4.1 trillion, was invested in mutual funds. The most common type of funds held in IRAs were equity funds with $2.1 trillion, followed by $839 billion in hybrid funds.
Estimates of mutual fund assets held in retirement accounts are based on data from ICI’s Quarterly Questionnaire for Retirement Statistics, which gathers data from 22,016 mutual fund share classes representing approximately 87% of mutual fund industry assets at the end of the first quarter 2020.
It’s worth reiterating that these findings are from the end of the first quarter, when the COVID-19 pandemic was wreaking havoc on the markets. Since then, the markets have generally shown some improvement, though we’re not out of the woods yet. Additionally, consider that the S&P 500 Index for the first quarter declined by nearly 20% and the Russell 2000 Index declined by more than 30%. Ted Godbout, NAPA, www.napa-net.org, June 23, 2020.
2. IRS NOTICE DETAILS RMD ROLLBACK PROCESS UNDER CARES ACT:
The Internal Revenue Service (IRS) has published Notice 2020-51, through which it is providing rollover relief for required minimum distributions (RMDs) from retirement accounts that were waived under the Coronavirus Aid, Relief and Economic Security (CARES) Act.
The upshot of the relief is that anyone who already took an RMD in 2020 from certain retirement accounts now has the opportunity to roll those funds back into a retirement account following the CARES Act RMD waiver for 2020.
The notice provides that this repayment is not subject to the one rollover per 12-month period limitation and the restriction on rollovers for inherited individual retirement accounts (IRAs). It also provides two sample amendments that employers may adopt to give plan participants and beneficiaries whose RMDs are waived a choice as to whether or not to receive the waived RMD.
Under Notice 2020-51, the 60-day rollover period for any RMDs already taken this year has been extended to August 31. The notice answers questions regarding the waiver of RMDs for 2020 under the CARES Act. That law enables any taxpayer with an RMD due in 2020 from a defined contribution (DC) retirement plan--including a 401(k), 403(b) or IRA--to skip those RMDs this year. This includes anyone who turned age 70.5 in 2019 and would have had to take the first RMD by April 1, 2020. John Manganaro, PLANSPONSOR, www.plansponsor.com, June 23, 2020.
3. HEAD OF KENTUCKY PENSION SYSTEM SAYS ‘TRAIN IS ON THE TRACK’ FOR RETIREMENT PLANS DESPITE COVID-19 UNCERTAINTY:
Kentucky’s pension systems are ranked as the worst-funded in the nation. Kentucky Retirement System (KRS) Executive Director David Eager sat down with The Bottom Line to discuss the current funding level of the system, the impact of an economic downturn and market turbulence, and more.
In the wake of the COVID-19 pandemic, the country and state are facing economic downturns and the stock market is experiencing many changes. For many years, lawmakers have expressed concerns about what would happen to KRS, which is only 14% funded, in the event of another deep recession or harmful economic event.
Eager noted the system is currently cash flow positive, meaning they are bringing in more money than they are paying out. He stated he does not expect the system to experience huge issues as a result of the pandemic.
In terms of whether or not the state is seeing a spike in people retiring due to uncertainty, Eager said the system is actually experiencing a decline in retirements and credited that to fewer people now being in the system and the likelihood many individuals likely want to keep the stability of their employment in such turbulent times.
The pension system lowered many assumptions in recent years, including assumed rates of return on investments, payroll growth and life expectancy of their members. Eager noted the system’s investment returns have been better than expected and despite the turbulence in the market, he expects each of the plans within the retirement system to end the year with slightly positive, stating the plans are in “excellent shape, relatively speaking.”
The Kentucky General Assembly ended up passing a one-year budget and cut in many areas during the 2020 session due to the uncertainty and lost revenue caused by the COVID-19 pandemic. When asked if KRS got what it needed in the budget, Eager said the legislature did fund the retirement systems at the required levels and while they would have loved additional revenue to help with the unfunded liability, the system is currently in a good position and the funded status will likely remain stable.
As for problems that could be facing the pension system in the near future, Eager discussed what’s referred to as the “death spiral” where the employer contribution rate continues to rise (currently at 84% of pay for many employers) and many choose to move to use independent contractors rather than hiring new people into the system, further exacerbating the funding issues facing the system.
Eager said there was a bill proposed in the 2020 session that would have helped with this issue in some way but it did not see the finish line. When asked if he would like to see the bill come back up in 2021, Eager stated he doesn’t believe there will be the political appetite to pass such a bill through the legislature. Jacqueline Pitts, www.kychamberbottomline.com, June 22, 2020.
4. ILLINOIS PENSION COMMITS AROUND $1.23BN TO PRIVATE MARKET FUNDS:
The Illinois pension plan for public school employees has committed around $1.23bn to private markets funds in recent weeks and has engaged three firms to provide consulting services on co-investment opportunities through its $6.5bn private equity portfolio.
The Teachers’ Retirement System of the State of Illinois, a pension plan that covers school employees in the state outside of Chicago, has committed $775m to funds from six private equity firms, according to a news release. The investments build on existing relationships with each fund manager for the pension fund, which had $50.6bn in assets under management as of 31 May.
Among them, the system committed $200m to Silver Lake Partners VI, an Illinois spokesman said. The fund is seeking $18bn in capital, according to documents from the New Jersey Division of Investment. Silver Lake already manages $350.3m of the Illinois pension’s assets, according to the news release.
Other private equity commitments made by the pension system include $100m to Altaris Capital Partners for its latest healthcare fund, Altaris Health Partners V. The healthcare investment specialist aims to raise $2.5bn for the new capital pool, WSJ Pro Private Equity reported in January.
The retirement system also pledged $200m to EQT IX, the ninth flagship fund for EQT Partners. Stockholm-based EQT is seeking €14.75bn for its new vehicle, according to a firm news release.
The pension plan also committed $150m to New Mountain Partners VI. New Mountain Capital has set an $8bn target for its latest fund, according to documents from Pennsylvania’s Public School Employees’ Retirement System. In addition, the plan agreed to invest $75m in Vista Foundation Fund IV. Vista Equity Partners aims to collect $3.25bn for its latest foundation vehicle, WSJ Pro Private Equity previously reported.
Finally, the pension system committed $50m to Pamlico Capital V, which wrapped up fundraising in February with $1.4bn, according to a news release. As part of its effort “to get flexibility in the marketplace,” the pension system hired three new advisers, Stout Risius Ross, Aksia and Meketa Investment Group, to develop private equity co-investment opportunities.
Within its $8bn real assets portfolio, the pension plan committed $450m to infrastructure funds and established a new relationship with Brookfield Asset Management, one of the biggest infrastructure investors. The pension plan committed $250m to the firm’s Brookfield Infrastructure Fund IV-B LP. The Toronto-based firm manages more than $515bn across strategies that include private equity and credit, infrastructure and renewable power.
The pension also allocated $200m to Strategic Partners Infrastructure III, Blackstone Group’s third secondaries fund for investing in infrastructure. Blackstone already manages $620.6m of the pension plan’s assets, according to the news release.
The Illinois system began the year with $54.2bn in assets and said it ended the first quarter with $48.6bn, reflecting market declines prompted by the coronavirus pandemic.
The plan said its losses were lower than most pensions, however, as only about 32.5% of its assets were invested in publicly traded equities and 26% were in bonds in the first quarter. During that period, 15.7% of plan assets were in real estate, while 13.4% were in private equity funds and about 11.6% were in diversified strategies, according to the news release. Preeti Singh, www.penews.com, June 22, 2020.
5. GRAND TRAVERSE COUNTY MICHIGAN COULD FULLY FUND PENSION DEBT WITHIN DECADE, SEEKS OPTIONS FOR LEAVING MERS:
Grand Traverse County commissioners reiterated their commitment to an aggressive payment schedule that could fully fund the county's $99.7 million pension debt in 10 years -- but expressed frustration with their pension provider, directing staff to explore the county’s options for leaving the Municipal Employees’ Retirement System (MERS).
County Administrator Nate Alger provided commissioners with an update on the county’s pension status, noting that the county is now 54 percent funded on its debt. Michigan law requires municipalities to pre-fund their pension plans at a minimum 60 percent level, a goal Grand Traverse County has been working hard to meet. Commissioners agreed last year to increase the county’s annual payment to MERS from a required minimum of $5.9 million annually to $7 million. That aggressive payment schedule should 100 percent fund Grand Traverse County’s debt within a decade based on MERS projections, according to Alger.
That timeline could be further accelerated by commissioners’ decision Wednesday to change a budget policy to direct even more payments toward the pension debt. Grand Traverse County has a $17.2 million fund balance as of December, or an approximately 34 percent unrestricted fund balance, according to Alger. County policy is to maintain a fund balance of 25 percent. Heading into budget planning for 2021 in the coming months, commissioners will need to draw down the fund balance by nine percent. The board agreed Wednesday that any excess funds should be distributed in three ways: 25 percent going to MERS as an extra payment above the county’s annual $7 million payment, 50 percent going to the county’s capital improvement fund, and 25 percent going to the county’s budget stabilization fund (a rainy day/emergency fund).
“Hopefully if we continue to do well on our budgets, we'll be able to contribute more funds to MERS,” said Commissioner Gordie LaPointe. He noted that funding the pension debt is the county’s most pressing obligation, saying that “we can lay everybody off…but paying the pension is non-negotiable. So I think that has to be a top priority.” While Commissioners Bryce Hundley and Sonny Wheelock opposed the fund balance policy change, saying they wanted to have the option to consider using excess funds for other county services, Chair Rob Hentschel agreed with LaPointe. “We'd be even farther behind (on the pension debt) if we didn't pay more,” he said. “Paying more is the only thing you can do to help."
While commissioners were generally unified on the overall importance of paying down the pension debt, they also expressed nearly unanimous dissatisfaction with MERS. Even with the county’s $7 million payment and a stock market boom in 2019, the county’s overall funded status remained nearly the same. While MERS reported a 13.41 percent market rate of return in 2019, the provider also “smooths” that rate out over a five-year period, resulting in a 4.77 percent smoothed rate last year. Alger acknowledges he was disappointed in that figure. “I would have hoped to see a larger increase in the smoothed funded level, but we don’t control that,” he tells The Ticker.
Some commissioners were more blunt in their reactions, with both LaPointe and Wheelock saying they “don’t trust” MERS and don’t believe the organization’s numbers. “If they were my financial planner, I’d be long gone,” said LaPointe. “They’re the financial planner of the county…and I don’t believe these numbers at all. If it was my money, I’d take a hard look at going elsewhere.” LaPointe said he’s tried in the past to get answers from MERS on various calculations and details related to the county’s plan, but would either receive responses weeks later or not at all. “It’s not rocket science to do these calculations,” he said. “I think we owe it to the taxpayers to see if there are other alternatives.”
Wheelock – who has sat on past commissions that also considered leaving MERS and has long expressed his frustration with the provider – echoed LaPointe’s remarks and reiterated his support for exploring options to leave. County staff said they had a thick technical document from MERS outlining a process for leaving the provider, but said it was such a significant move that they’d prefer having outside legal counsel review the document and provide an analysis on the county’s options. Wheelock said commissioners shouldn’t trust MERS to advise them on how to pull tens of millions of dollars in assets from the provider and agreed getting an “educated opinion about what our options are” was the best route. Wheelock made a motion to have staff seek outside guidance and schedule an upcoming study session on the topic – a motion approved by the board.
Following the meeting, The Ticker reached out to MERS representatives for comment. In an email, Communications and Retirement Strategies Director Jennifer Mausolf wrote that “as the plan’s fiduciary, MERS’ role is to help ensure that the assets within the Grand Traverse County retirement plan are adequate to provide for the retirement benefits of their employees. We stand ready to continue partnering with the county in addressing their unfunded retirement liabilities or to support them if they choose to transition away from MERS.”
Mausolf notes that MERS is a nonprofit organization that has “helped provide a secure retirement for municipal employees for more than 75 years,” adding that “transparency and responsiveness to our customers are a critical part of our organization’s focus and mission.” MERS is governed by an elected board that “operates without compensation,” according to Mausolf.
“We are subject to FOIA (Freedom of Information Act), just like our membership, and are proud of our track record of transparency, accountability, and fiscal best practices,” she wrote. Beth Milligan, www.traverseticker.com, June 25, 2020.
6. SOUTH DAKOTA PENSION SYSTEM RESPONDS TO PANDEMIC-RELATED MARKET DOWNTURN:
Among nation’s best funded, the state program explores ways to balance fiscal sustainability and retirement security. The South Dakota Retirement System (SDRS) board has met repeatedly to discuss how best to weather the economic turmoil created by the coronavirus pandemic. In particular, the trustees have focused on whether current state policies will be sufficient or additional measures will be needed to ensure that the public employee pension system can maintain full funding.
Their transparent process helps to shed light on how one of the best-funded pension systems in the country is effectively managing market risk and navigating economic uncertainty. At a recent meeting, advisers informed the board that based on improved returns through the end of May, 2020, they did not expect the fiscal year 2020 results to require immediate action. As of 2019, SDRS has reported a 100% funded ratio, meaning that plan assets match accrued liabilities.
In addition to making the contributions to the system required by actuarial calculations each year, South Dakota has benefited from implementing predefined cost-sharing policies that manage the plan’s exposure to market risk.
SDRS trustees discussed this variable benefit design put in place before the last recessions at meetings earlier this year. Board members and advisers at the sessions talked through ideas on how best to manage the stock market uncertainty associated with COVID-19 while ensuring continued retirement security for workers and retirees.
How the SDRS cost-sharing policies work
The SDRS cost-sharing provisions are based on statutorily fixed employer and employee contribution rates of 6% of payroll for each. If returns on investments fall short of expectations or exceed plan targets, the predefined variable benefit policies automatically adjust to ensure that the plan remains 100% funded--without increasing contribution rates. Under this structure, the annual cost-of-living adjustments (COLAs) are tied to the consumer price index. The adjustments are capped automatically within a range of 0.5 to 3.5% based on what will be needed to maintain full funding. The system also assumes a lower rate of return on plan investments, 6.5% compared with a national average of 7.25%. That helps reduce the risk of missing the return target and incurring unexpected costs during market downturns. SDRS also regularly publishes stress test analyses--which examine possible scenarios--to educate stakeholders about the potential impact of an economic downturn on the plan and workers. The trustees can use this information to better understand the potential impact of the pandemic.
Potential responses to economic downturn
The board of trustees discussed the current economic situation and the possible impact on the system’s fiscal health. SDRS actuaries reported that returns that drop as low as negative 7.1% in fiscal 2020 would be addressed automatically by reducing the COLA cap to the statutory minimum of 0.5% for one year.
If losses are greater than that, plan advisers recommended that the COLA policy be revised so that the cap could automatically drop as low as 0%, resulting in no adjustment in a given year. Such a change would require legislative approval and allow the fund to absorb losses associated with a negative 11.6% return on investments. Initial feedback on strengthening the variable COLA proved positive, with at least one trustee representing retired members voicing support.
The board also discussed two other actions at the March meeting, both of which have since been tabled. They were to allow a small unfunded liability for a short period of time and to suspend the state contribution to a supplemental employee account and change benefits going forward for some workers.
At the June 3, 2020 meeting, the state investment officer reported that current return expectations are closer to 0.5%. As a result, no additional changes are expected to be necessary at this time for the plan to maintain full funding; the plan now expects to be able to grant a small COLA in the next fiscal year. However, the actuaries cautioned that circumstances could change quickly and the plan should be ready to consider additional corrective actions if needed. In addition, staff is recommending that the variable COLA be strengthened starting in 2021.
Cost-sharing policies such as South Dakota’s effectively keep employer costs stable, but they have an impact on workers and retirees. Still, career employees receive full or close to full income replacement through the core defined benefit combined with Social Security. The plan also includes provisions that ensure that workers who leave midcareer are on a path toward retirement security with protections against inflation, as well as an option to claim a portion of employer contributions if they leave before retirement.
Because the COLA is determined automatically based on plan funded status and inflation, the short-term benefit reduction would be in place only until the plan’s financial health improves. Changes to the benefit would apply to both today’s retirees and career workers once they retire--and both would have advance notice on the variable COLA. With the steps already taken and the attention paid to funding issues now, South Dakota serves as a strong example of how states can act to maintain fiscal sustainability while providing promised retirement security to their workers. David Draine & Aleena Oberthur, www.pewtrusts.org, June 23, 2020.
7. WHY YOU SHOULD WORRY ABOUT THE PENSION FUND CRISIS:
State and local government pension funds are making unrealistic assumptions about their likely future returns. That’s bad news for more than just the government workers whose retirement security is dependent on receiving their pension benefits. It’s also bad news for taxpayers who will ultimately foot the bill of overcoming shortfalls. And it’s also bad news for the economy as a whole, given the sheer size of those deficits.
To put the pension funding deficit into perspective, consider the student loan crisis, which has gotten lots of attention in recent years for its potential to trigger another credit crisis like the one we saw in 2008 and 2009. Total student loan debt is estimated to be $1.5 trillion, which turns out to be only a fraction of the state and local government pension fund shortfall.
Consider that such pension funds held $4.8 trillion in assets at the end of 2019, and that Goldman Sachs estimates that those assets represent less than 60% of pension fund liabilities. That implies a funding shortfall of over $3 trillion, double that of student loan debt. And unrealistic return assumptions are likely to make the problem get progressively worse in coming years. According to a February report from the National Association of State Retirement Administrators (NASRA), the average public pension plan is assuming a 7.22% annualized return going forward. I seriously doubt this target will be met.
According to NASRA, the bulk of public pension plans -- 71% -- is invested in stocks and bonds, with approximately two-thirds of this amount allocated to stocks and one-third to bonds. Let’s first consider the contribution that bonds will make to hitting the pension funds’ return target. We know with some precision what that contribution will be, since bonds’ initial yield is very highly correlated with bonds’ long-term subsequent return -- as you can see from the accompanying chart. (The correlation coefficient of the two series is an incredibly high 0.97, just shy of the theoretical maximum of 1.0.)
So we can forecast with high confidence that bonds’ future return from here will be around 2.5% annualized, which is where Moody’s Seasoned Aaa Corporate Bond Yield currently stands. A quick back-of-the-envelope calculation tells us that stocks will have to produce a 9.5% annualized return in order for the average pension fund’s stock-bond portion to hit its return target of 7.22% annualized return.
Consider the projections of seven valuation indicators I follow, each of which has a statistically significant track record of forecasting the stock market’s subsequent 10-year real return. I know of no other indicator that has as good a track record. These seven are: The q-ratio, the Buffett ratio, the price-to-book ratio, the price-to-sales ratio, the dividend yield, the cyclically-adjusted P/E ratio, and household equity allocation.
On average, these seven currently are projecting a 10-year real-return for the S&P 500 of minus 2.4% annualized. (The range is from minus 9.4% annualized on the low end to plus 2.4% annualized on the high end.) Add in expected inflation over the next decade of 1.2% annualized (according to a model devised by the Cleveland Federal Reserve) and we arrive at a nominal (before-inflation) return forecast of minus 1.2% annualized.
Putting together these bond and stock forecasts, our best guess of the future return of the stock-bond portion of the average pension fund is therefore about 1.7% annualized. That’s 5.5 annualized percentage points shy of the average fund’s target return.
None of this will come as a surprise to pension plan administrators, which is why they have steadily increased their allocations over the years to alternative investments -- now 19.3%, according to NASRA. The hope is that these alternatives will produce much higher returns than equities, of course. My review of the research suggests that these advertised higher returns are exaggerated. But even if not, bear in mind that those alternative investments are much riskier, so during any economic downturn they could produce outsized losses. In any case, this alternative-investment category will have to produce wildly unrealistic returns to overcome stocks’ and bonds’ low expected future returns.
We can all hope that this analysis is wrong, of course. But hope is not a strategy. It is far better to be realistic, since the longer that state and local governments put off real solutions the harder it will be to overcome their pension funding shortfalls.
Each of us individually should also take these lessons to heart. While you may not know with precision the return target that is assumed by your retirement financial plan, that target very much exists at least implicitly. It behooves you to find out what it is, and then to subject it to historical scrutiny. If you decide that you should lower your return target, and that this in turn reduces your projected retirement income, it’s far better to know that now and plan accordingly. Mark Hulbert, www.thestreet.com, June 24, 2020.
8. DOL FILES BRIEF IN CASE OVER ERISA PREEMPTION OF CALSAVERS:
In an ongoing legislative battle over the legality of the California Secure Choice Act, which led to the establishment of a state-run automatic individual retirement account (IRA) program, attorneys for the U.S. Department of Labor (DOL) have filed a brief explaining how it believes a federal district court got it wrong.
The complaint was originally filed in 2018 by the Howard Jarvis Taxpayers Association and alleged the act that created the California Secure Choice program, now known as CalSavers, “violates the Supremacy Clause of the United States Constitution because it is expressly pre-empted by the Employee Retirement Income Security Act [ERISA] of 1974.” The case was dismissed in March with the court finding no impermissible reference to or connection with ERISA plans in the statute.
In its brief filed with the 9th U.S. Circuit Court of Appeals, the DOL notes that the act establishes a trust with IRAs for employees and a governing board that invests the trust’s assets. It requires certain employers that do not otherwise offer a retirement plan or automatic enrollment IRA to “have a payroll deposit retirement savings arrangement” for employees to participate in CalSavers. The arrangement must have automatic enrollment, though employees may opt out.
To comply with the act, employers either must have an ERISA-covered retirement plan or must use the CalSavers withholding arrangement. The DOL argues that if employers use the withholding arrangements mandated by the act, they establish or maintain plans, funds or programs of benefits for their employees, which therefore are themselves ERISA-covered plans. “The fact that the withholding arrangements are compelled by state law does not alter the ERISA pre-emption analysis,” the brief states.
The DOL argues that the law establishing CalSavers is pre-empted under the legal doctrine that state law relates to an ERISA plan if it has a connection with or reference to such plans. The agency says this is because it both governs a central matter of plan administration and interferes with nationally uniform plan administration--by subjecting multi-state employers to a patchwork of state laws that directly regulate how employers must structure their program or plan in providing retirement benefits.
According to the DOL’s brief, the arrangements mandated by the act meet the test set forth in Donovan v. Dillingham to determine whether a plan, fund or program exists. These include:
- The “intended benefits” are the retirement income from tax-deferred contributions provided by the IRAs required by the act;
- the “beneficiaries” are the employees whose wages are withheld;
- the “source of financing” is the automatic payroll deductions; and
- the “procedures for receiving benefits” are those provided through the IRA product.
Once it is determined that the act’s mandated withholding arrangements are plans, funds or programs of benefits, the DOL says, it is necessary to determine next whether they are established or maintained by employers. Citing Advocate Health Care Network v. Stapleton and Donovan, the brief states, “Establishment of a plan … is a one-time, historical event,” that results in “a reasonable person [being able to] ascertain the intended benefits, a class of beneficiaries, the source of financing and procedures for receiving benefits.” The agency points out that the arrangements would be ERISA-covered plans if the employers had voluntarily set up identical IRA arrangements for their employees and hired CalSavers to manage those investments. “The Supreme Court has held that a plan otherwise covered by ERISA does not escape pre-emption purely because state law mandated its existence. Thus, the identical state-mandated plan is treated as equivalent to plans established by employers and subject to ERISA,” it says.
The DOL further argues that the act’s mandated withholding arrangements are ERISA-covered plans because the covered employers “maintain” them in a manner sufficient for ERISA coverage. The statute and its regulations define the employer’s administrative responsibilities--requiring that employers continually update their payroll deductions to reflect changes to their workforce of eligible employees, their employer eligibility and the fluctuating contribution rate for each employee.
The DOL says courts recognize that when a state law requires such ongoing eligibility determinations in combination with an ongoing administrative scheme, then the employer’s required activities will be sufficient to establish or maintain an ERISA-covered plan. “By requiring employers to deduct contributions from eligible employees’ wages on an ongoing basis, and to forward the contributions for deposit into IRAs established for each enrolled employee, the Secure Choice Act requires the employers to maintain an employer-based program providing ‘retirement income to employees’ or resulting ‘in a deferral of income by employees for periods extending to the termination of covered employment or beyond,’” the brief states.
The DOL says the district court was correct in rejecting the argument that CalSavers can avoid pre-emption because the withholding arrangements avoid ERISA coverage under the DOL’s safe harbor regulation. The district court found that because employees are automatically enrolled in the program, the arrangements are not “completely voluntary” as required by the safe harbor.
The safe harbor regulation provides that ERISA does not cover a payroll-deduction IRA arrangement otherwise covered by ERISA so long as certain conditions are met, including:
- the employer makes no contributions;
- employee participation is “completely voluntary”;
- the employer does not endorse the program and acts as a mere facilitator of a relationship between the IRA vendor and employees; and
- the employer receives no consideration except for its own expenses.
The brief notes that prior courts have held that opt-out arrangements are not “completely voluntary.” “To further ERISA’s protections of participant choice, the safe harbor requires a ‘completely voluntary’ rather than a merely ‘voluntary’ choice, and this heightened protection bars opt-out regimes, like CalSavers, from the department’s safe harbor regulation,” the brief states. Rebecca Moore, Planadviser, www.planadviser.com, June 25, 2020.
9. LONGEVITY AND RETIREMENT EXPERTS ENCOURAGE RETENTION OF OLDER WORKERS:
During a webinar held on longevity and retirement, speakers said that, because people are living longer, workers want to remain in the workforce longer and policymakers and employers need to recognize this. They also said a multigenerational workforce is not only more productive, as people from as many as five generations share ideas, but that it is more profitable.
The Aegon Center for Longevity and Retirement, Transamerica Center for Retirement Studies and Instituto de Longevidade Mongeral Aegon hosted the webinar called, “Age-Friendly Employers Are Integral to the New Social Contract for Retirement.”
In his introduction, Mark Twigg, executive director of Ciero/AMO, and moderator of the panel, said the relationship between employees and employers is evolving. “Longevity means we need to rethink retirement,” Twigg said. “For many, employment is becoming more flexible.” He noted that a survey of 60,000 workers that the three sponsors conducted in 15 countries found that “57% expect a phased transition into retirement because they want to stay active and for financial reasons. However, 33% of workers do not think their employer is fostering a multigenerational workforce.”
Twigg said the survey also found that 26% of workers said they receive no training to keep their skills up to date. He noted that, beyond training, employers could help older workers to remain in the workforce by allowing them to transition from full-time to part-time work. Currently, only 28% of workers are given that option.
Debra Whitman, executive vice president at AARP, said, “It is important that when we say ‘age-friendly,’ we mean all age friendly--that is meeting the diversity of all of your employees and their needs. Women have children and take maternity leave. Many people are caregivers for parents or relatives. Employers need to think more broadly about the care needs of workers in an inclusive environment.”
If employers need to be convinced of the benefits of a multigenerational workforce, Whitman said, “If we allowed all people who wanted to work to do so, GDP [gross domestic product] would be 19% higher. Employers should care because mutigenerational teams work better and meet the needs of the market better. We did a study on the longevity economy. Older Americans would contribute $8.3 trillion of economic activity.”
Catherine Collinson, CEO and president of Transamerica Center for Retirement Studies, said, “In our work, we like to define an ‘age-friendly employer’ as one that offers diversity, inclusivity and that is age friendly. We need to reimagine the way people live, work and retire. Retirement systems around the world are undergoing severe strain due to increases in longevity, population aging, globalization and evolving employment trends. The coronavirus pandemic and economic downturn are intensifying existing risks to retirement security--and creating an even greater urgency for a new social contract among governments, employers, individuals and other stakeholders. Individuals are increasingly expected to self-fund retirement income, but only 25% of workers feel they are on the right course to meet their retirement income needs.”
Where can employers start? Since only 52% of workers are offered a retirement plan, Collinson called this “a really important starting point,” along with all the other services than come with a plan, such as investment guidance and financial wellness resources.
Collinson then outlined what she said she believes to be the five fundamental aspects of retirement readiness: “Save early and habitually. But only 40% of workers right now are habitual savers. Second, have a retirement strategy. Only 17% have a written plan for retirement. Third, have a back-up plan for life’s unforeseen circumstances. Only 35% have a back-up plan should they be unable to work before their planned retirement. Fourth, adopt a healthy lifestyle so you can work as you would like or need to. Fifth, embrace lifelong learning and improve financial literacy.”
For their part, employers not only have to offer retirement plans but, Whitman said, “make sure the benefits you offer are affecting all of your employees and meeting their unique needs across the lifespan.”
Whitman also encouraged employers to employ “age-blind hiring,” noting that, “discrimination against older people is real. We are losing a lot of talent and productivity.”
Collinson noted that policymakers are thinking about increasing the retirement age. “This is a really big issue and should become a greater topic of conversation,” she said. “We have a long way to go in terms of a policy and employers supporting these new realities.” Whitman added: “Those countries that embrace the needs of an aging society will be the countries that succeed.” Lee Barney, PLANSPONSOR, www.plansponsor.com, June 24, 2020.
10. FUTURE RETURNS: AN ACTUARIAL TAKE ON POST-COVID-19 INVESTING:
Paul Sandhu, head of multi-assets quant solutions and client advisory, APAC at BNP Paribas Asset Management in Hong Kong, believes an investor’s portfolio should have a different makeup after Covid-19, just like it should have had following the 2008 financial crisis.
“If our portfolios are looking the same as they were for the last 10 years, then that’s something that needs to be really thoroughly understood,” Sandhu says. “Why is that? Because the market is so different.” Looking closely at how countries responded to Covid-19 to mitigate economic risk, and how they subsequently fared, is a good way to underscore these necessary changes, he says.
Sandhu advocates taking a closer look at the economic capital of countries going forward, like an actuary might--because how countries fared with Covid-19 will help dictate how they respond to future crises, and, in turn, how investing in that country can impact a portfolio.
“Countries with relatively lower growth rates will be more susceptible to growth-rate shock in a crisis situation such as a pandemic,” he says. “They cannot afford to be tactical during these times, so a strategic planned stimulus reserve or buffer would be ideal.” Countries with higher absolute GDP growth, such as China--6.1% in 2019 compared to 2.3% in the U.S.--have room to fall further before they enter a decline, allowing them to maintain upward momentum while sustaining some shocks.
Developed markets “have to do this very reactive and very strong stimulus to put a hedge on the economy, whereas economies like China, for example, can be a little bit more practical in a sense because they already have that flow,” Sandhu says.
To adjust an investment portfolio for the coming years in the wake of Covid-19’s impact, Sandhu offers these three tips.
Use Covid-19 as a Diversification Barometer
“We’ve been pressing on investors to move into more diversified strategies for quite some time,” Sandhu says. One particular challenge has been that the U.S. equity market has been so bullish that in the minds of some investors, “the biggest risk is being out of the market.”
But in setting up a portfolio with the next decade in mind Sandhu says adding additional asset classes and geographies is key. It can be as little as adding another asset class or two or expanding beyond usual borders, but there has to be a logic when selecting emerging markets, given their added risk. How countries fared with Covid-19 both economically and from a public health perspective offers useful guidance.
Focus on markets that have done well mitigating this virus, he says. They “are going to be able to get their feet on the ground more firmly going into the next 10 years than other markets.”
Use Volatility to Generate Alpha Opportunities
Going forward, Sandhu doesn’t see volatility being as low as it was in the last 10 years. “The general investment market is not going to be led by the broad market,” he says. He thinks statically investing in exchange-traded funds just to gain broad market exposure could lead portfolios to a lot of volatility, potentially creating excessive downside risk.
“A better way of doing that which we’ve been prescribing to investors is to hedge that downside risk and focus on [market-beating] opportunities,,” he says. Sandhu says BNP Paribas has been applying downside soft or hard protection to most of the portfolios it builds.
“Soft protection is more focused on maintaining a certain level of volatility,” he says. “So if the volatility increases by too much, then what we do is we start de-risking.” As a hard protection mechanism, they buy put options to floor any kind of potential loss. A put gives an investor the right to sell a security at a predetermined price within a specified time period.
“But in order to be more cost efficient about buying puts, we’ll do something else such as selling calls [options to buy versus sell] on the upside in order to pay for the puts on the downside,” he adds.
Don’t Worry About Timing the Market’s Bottom
Despite investor concerns about finding the market’s bottom, or if there will be another, Sandhu says that’s not going to matter over a 10-year period. “If you were to pick the bottom of the 2008 financial crisis, 10 years later, you would have earned about 350%,” he says, though an investor would have had to do so within a week before or after that day. “If I was beyond that week, up to about two or three months, I still would have made about 300%.”
Of course investors want extra returns, he says, but investors have to ask if it’s going to be that important over 10 years as they re-adjust post-Covid-19. Instead, he says, investors could enjoy “pretty strong upside” by diversifying and planning their portfolios, rather than worrying about picking the bottom.
“And that’s one of the reasons why we’re pushing building diversified strategies instead of trying to time the market, in terms of when should we get out, when is it going to bottom out? Because that’s always a difficult thing to do.” Rob Csernyik, www.barrons.com, June 23, 2020.
11. OUCH! COVID-19 IS FORCING SOME PEOPLE TO PUT RETIREMENT ON HOLD:
The pandemic has made Jennifer White, 47, fearful about whether early retirement is possible. White, director of education abroad at Eastern Kentucky University, is grappling with whether her goal of retiring at 60 is still achievable after the deadly virus upended the school’s study abroad programs in dozens of countries across Europe, Asia and South America.
“I already felt like I was playing catch-up with retirement. There’s a fear of what the future holds and an overwhelming sense of doom with the pandemic,” White says, who has been working from home. “Universities all over the country are experiencing lower enrollment, so it’s going to be devastating for higher education.”
Retirement security shaken
The recession has rattled retirement plans for Americans, as income and savings have been pressured by rising unemployment and market swings. About 30% of employed investors say it’s very or somewhat likely that they will delay the age at which they retire as a result of the recent economic downturn, according to the Wells Fargo/Gallup Investor and Retirement Optimism Index. A similar percentage, 29%, think it’s likely they will work more than they intended in their retirement.
In March, the Standard & Poor’s 500 index shed 30% from its record in just 22 trading days, the swiftest such drop in history. But stocks have recovered most of their losses since then. "Folks are worried that they'll have to delay retirement to offset recent stock market losses," says Dan Barry, regional president at Wells Fargo Advisors. “But market downturns are inevitable. If folks are concerned, they should stay the course and rebalance their portfolio because markets have proven over time that it pays off to remain invested.”
The survey, conducted from May 11-17, 2020, is based on interviews with adults in a household with stocks, bonds, or mutual funds of $10,000 or more, either in an investment account or in a self-directed IRA or 401(k) retirement account. Of total respondents, 40% reported annual incomes of less than $90,000; 60% reported $90,000 or more. The median age of the nonretired investor is 45 and the retiree is 69.
Optimism suffers record decline
Investor optimism tumbled to a seven-year low in the second quarter due to the economic fallout from the coronavirus pandemic, the study showed. In the April to June period, confidence hit its lowest point since the fourth quarter of 2013, an about-face after confidence had touched a 20-year high in the first three months of the year. Optimism fell the most on unemployment and economic growth.
Investors have felt the effects of the pandemic on the job market. As of the May survey, 27% of nonretired investors had suffered a loss of income or pay, 15% had been furloughed or temporarily laid off and 1% had been permanently let go.
The coronavirus has also compelled one in four investors to take on more financial responsibility for family members. The largest percentage, 16%, reports providing greater financial assistance to an adult child, while 7% say they have assisted a parent, and 7% another relative.
Investors confident over the long haul
To be sure, trends in the poll signal that investors view recent market disruption as temporary, not as an alarm of systemic problems that will harm their investments in the long term.
Most investors remain optimistic about reaching their five-year investing goals even as their 12-month outlook for their own investments is down sharply. Roughly two-thirds of investors polled remain optimistic about reaching their five-year investment goals, according to the study.
Six in 10 investors continue to say now is a good time to invest in the financial markets. One reason why: cheaper stock prices. “It’s really important to stay invested in a well, thought-out plan that aligns with your goals,” Barry says. "If you’re not invested, you can miss some of the market’s best days, which has historically shown could be detrimental to your portfolio in the long term.” Jessica Menton, USA TODAY, www.usatoday.com, June 24, 2020.
12. ONLY 47% OF AMERICANS ARE LOSING SLEEP OVER MONEY DESPITE PANDEMIC: STUDY:
Despite the coronavirus pandemic and a slowed-down economy, less than half of American adults are worried about money, according to a new Bankrate study. And more surprising than that, this number is down from the 56 percent who said they were worried about money in 2019.
For the 47 percent who are worried about money issues currently, 23 percent said their cause of stress revolved around everyday expenses, which Bankrate noted was down from the 32 percent who said the same last year.
“In the context of the worst unemployment crisis since the Great Depression, it’s shocking the figures aren’t far worse,” said Bankrate’s industry analyst Ted Rossman regarding the findings. “Government stimulus programs are helping, and many who are currently out of work seem confident they will soon return. It also helps that the economy was in good shape prior to the COVID-19 pandemic.”
Outside of everyday expenses, the next most worrisome money trouble for Americans revolve around saving enough for retirement – a concern that 19 percent admitted keeps them awake at night. However, this percentage is five percent less than what was recorded in 2019.
Health care or insurance bills were the third most worrisome at 17 percent, which is down from the 22 percent who reported last year. Paying a mortgage or monthly rent bill was the fourth most common money concern Americans have for 2020 at 14 percent – down from 18 percent last year.
Credit card debt was another significant concern at 13 percent, though it’s also down from 18 percent in 2019. Next on the list of money issues was the ability to pay for education expenses at eight percent, which is down from 11 percent last year.
The stock market was the least worrisome money concern out of the group at six percent having admitted that they have lost sleep over stock market volatility, which is up one percent from last year. When compared to relationships, health and work, 31 percent of the study’s respondents said they lost sleep over money. Nineteen percent said relationships cost them sleep while 13 percent said health cost them sleep and 11 percent said work cost them sleep. On average, the study said Americans lose sleep to one of the three issues.
Though, women reported losing more sleep to one of these issues than men at 79 percent versus 70 percent, respectively. Of those who are concerned about their finances at this time, 59 percent said they are optimistic that they’ll be able to resolve their top money concern at some point. However, this percentage is down from 63 percent who said the same in 2019.
Bankrate did note that this dip in optimism could be a result of the coronavirus pandemic. Fifty-two percent told the personal finance resource that the pandemic has impacted their resolve negatively while 39 percent said the pandemic didn’t change their resolve either way and 10 percent said the pandemic impacted their resolve positively.
“I’m really surprised Americans are more upbeat this year than they were last year,” Rossman added in reference to the study. “Right now, we’re experiencing some of the greatest societal, health and monetary challenges of our lifetimes. Yet in the face of all that, our survey found consistent improvement from last year.” Cortney Moore, Fox Business, www.finance.yahoo.com, June 24, 2020.
13. LABOR DEPT. SEEKS TO RESTRICT SOCIAL GOALS IN RETIREMENT INVESTING:
A proposed rule would keep plans from increasing risk or decreasing returns in pursuit of “a social or political end,” Secretary Eugene Scalia says. But others say existing law achieves that end.
The Labor Department is seeking a new federal regulation that could discourage retirement funds from making investments based on environmental, social and governance considerations. The department said in a news release that it was taking the action to “provide clear regulatory guideposts.” Labor Secretary Eugene Scalia, in an opinion article in The Wall Street Journal, said the move “reminds plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”
Investments based on social goals can consider, for example, a company’s efforts to reduce its carbon footprint or to promote racial and gender diversity among its directors and executives. Such investments have grown immensely in recent years, to roughly one of every four dollars under management, according to the US SIF Foundation, a nonprofit focused on the category. While little of that was in workplace retirement plans, some experts think 401(k) plans will play an increasing role in such investing.
But experts said the proposed rule would not meaningfully change employers’ obligations. And Morningstar has found that funds based on environmental, social and governance goals -- known as E.S.G. factors -- outperformed conventional offerings during the first quarter of this year and going back several years as well.
Under the Employee Retirement Income Security Act of 1974, known as ERISA, administrators overseeing employee retirement plans -- usually an employer’s financial or human resources officials -- are required to act in the strict financial interests of workers. That typically means they can add a mutual fund option that emphasizes social and environmental goals only if they expect it to perform at least as well as an option that does not focus on those factors while taking similar risk.
“The Department of Labor has always taken the position that plans can take into account other factors, such as social and environmental, as long as they don’t increase risk or sacrifice return for the plan,” said Olena Lacy, who served as assistant labor secretary in charge of the agency overseeing employee benefits during the Clinton administration.
Ms. Lacy said Democratic and Republican administrations had simply differed over the years in framing the obligations of employee plan administrators.
“Democrats say the standard is that it’s OK for you do to this as long as it comes out the same,” she said, referring to risk and returns. “Republicans say it’s illegal for you to do this unless it comes out the same.”
Jon Hale, the head of sustainability research at Morningstar, said the practical effect of the new framing could be to deter plan administrators from adding E.S.G. options to 401(k) plans for fear of violating the law. Even if the proposal does not come to pass, he said, employers might decide to avoid E.S.G. investments because they see them as a potential political minefield.
The proposed rule says that environmental, social and governance concerns can be taken into account independent of factors like risk and return only if they act as a kind of tiebreaker when investments are otherwise financially indistinguishable. In that case, the rule would require plan administrators to document the investment analysis that led to the conclusion.
The department acknowledged that the provision might create additional burdens for employers, but said in a background document that it “does not expect this requirement to impose a significant cost as these situations are rare.”
In the Labor Department release, Mr. Scalia said the proposed rule was meant to ensure that social goals would not come at the expense of returns to participants in retirement plans, and the release says employers cannot invest in E.S.G.-focused funds that seek to “subordinate return or increase risk for the purpose of nonfinancial objectives.”
The department did not respond to a request seeking examples of employers that have pursued such strategies.
Jerome Schlichter, a lawyer who has successfully pursued numerous employers on behalf of workers over excessive fees in their 401(k) plans, said he was not aware of employers who had sought to pursue E.S.G. goals at the expense of financial returns.
“That has not been something that we’ve seen,” Mr. Schlichter said. “It hasn’t been done by fiduciaries in any broad way, in part due to concerns about exposure for litigation.”
Other lawyers said that while the growth in E.S.G. investment options and their rising popularity among workers could require additional regulation and enforcement, such action would typically be better aimed at investment companies marketing such funds, rather than employers and their plan administrators.
George Sepsakos, a lawyer who advises employer plans about their legal responsibilities, said the Securities and Exchange Commission had been reviewing disclosure from E.S.G. funds to make sure their marketing accurately reflected their investing strategies. “Right now the definition can mean different things to different people,” Mr. Sepsakos said.
He said that if an investment company had misrepresented potential returns or fees from an E.S.G.-focused fund, the investment company rather than the employer would typically be liable. “The plan fiduciary can only make investment decisions based on what they know or should have known at the time,” he said.
A 2015 academic paper examining decades of research and over 2,000 other studies found that about 90 percent of the work showed no negative connection between E.S.G. principles and corporate financial performance. A large majority showed positive findings.
As a result, said Mr. Hale of Morningstar, the proposed rule could end up being counterproductive. “Not only could investments that focus on the long-term sustainability of companies lead to truly long-term outperformance because you’re picking better quality companies,” he said. “But there is also the systems argument, that you’re helping to create a financial system and economy that will be more successful.” Noam Scheiber and Ron Lieber, NY Times, www.nytimes.com, June 24, 2020.
14. HOW TO AVOID A 10% BITE WHEN YOU DIP INTO YOUR RETIREMENT FUNDS:
In an effort to discourage the use of retirement funds for purposes other than retirement, Congress enacted a supplementary tax that applies to premature distributions.
However, the dreaded 10% Internal Revenue Code Section 72(t) penance does not apply to all withdrawals, and several statutory exceptions have been carved out. In addition, in the last six months the legislature has added new opportunities to circumvent the 10% penalty, which makes this a great time to review the topic.
Several statutory exemptions apply to all types of employer-provided qualified plans, 403(b) plans, IRAs, SEPs, and SIMPLEs. Please note that in many cases the withdrawals will be subject to ordinary income tax and will increase the amount you owe the government. However, the following cases, even though they may incur a tax hit, will escape the 10% penalty.
• Distributions resulting from the pandemic. If you qualify for a coronavirus related distribution (CRD), the 10% penalty does not apply to withdrawals that occur in 2020. The CARES Act (enacted in March 2020) specifies two categories of people who can get CRDs. First, you qualify if you, your spouse, or your dependent has been diagnosed with Covid-19. Second, undiagnosed people who have suffered adverse financial consequences because of the disease may also qualify. This includes individuals who have been quarantined, furloughed, laid off, had work hours reduced, or become unable to work because of child care responsibilities. Business owners and operators are also eligible if they have had to close the business or reduce hours. In addition to avoiding the 10% penalty it should be noted that the opportunity to take plan withdrawals has been loosened by many (but not all) employers.
• Distributions occurring after age 59½. These are not considered premature distributions even if you are still in the workforce, so no penalty tax applies. For example, if Tommy, age 61, takes a qualified distribution from his Roth IRA (he met the five-year holding period) to pay for personal expenses he qualifies for a tax-free and penalty free Roth distribution.
• Distributions arising from a death. Money paid to a beneficiary or an estate avoids the 10% penalty. For example, Tammy (age 50) is a widow who received a distribution from her deceased husband’s retirement plan. There is no penalty on the payment. However, if Tammy rolled the distribution to an IRA and then took a premature distribution, the penalty would apply. Once Tammy chose to rollover the funds into her own IRA, the source of the funds becomes irrelevant and she loses the ability to qualify for the exception from the 10-percent penalty.
• Distributions stemming from permanent or total disability. Another exception to the 10% penalty applies when you have a disability. The definition for disability has come to mean that you are permanently disabled and unable to do your prior job. Verification by a doctor will be required for this.
• Distributions based on qualified medical expenses. Note that not all medical expenses qualify (e.g., unnecessary cosmetic surgery is not qualified, but treatment by a doctor for a broken leg is qualified). You also need to understand that distributions for qualified medical expenses must exceed the itemized deduction threshold of AGI in the year taken (7.5% in 2019). The good news is that this provision applies even if the standard deduction is claimed. The bad news is this provision only applies to uninsured medical expenses.
• Distributions following the birth or adoption of a child. Effective Jan. 1, 2020, you are allowed to take a withdrawal for the birth or adoption of a child without the 10% penalty applying. The SECURE Act allows you to avoid the penalty on up to a $5,000 withdrawal ($10,000 for a married couple). You can take the withdrawal up to one year from the date of adoption or the birth of a child. You can also repay the $5,000 ($10,000) to your IRA should you come into money. One caveat -- the exception does not apply in a “Brady Bunch” situation. This is because an eligible adoptee is an individual other than a child of the taxpayer’s spouse who has not attained age 18 or is physically or mentally incapable of self-support.
There is a statutory exception that applies to all types of qualified plans, 403(b) plans, but not to IRAs, SEPs, and SIMPLEs. This exception is:
• Distributions proceeding from retirement after age 55. Under the so-called “age 55 exception” (age 50 if the person is a qualified public safety employee, e.g., police and fire) there is no penalty if you retire from the employer after age 55. For example, Ted retires from ABC Company at age 57. Ted can take withdrawals without triggering a penalty.
There are a few exemptions that apply to IRAs, SEPs, and SIMPLEs and not to qualified employer plans and 403(b) plans. Once again, an ordinary income tax will apply, even though the 10% penalty is circumvented.
• Distributions for purchasing the ‘first home’. The maximum that can be taken for the first-time homebuyer exception is $10,000 per person. The first-time homebuyer exception applies to you, your spouse, your child, or your grandchild. The law says “first-time homebuyers,” but in application this means anyone who did not own a home in the last two years, even if they owned a home before that. One final point, the distribution must occur within 120 days of acquiring (buying, building, rebuilding) the home.
• Distributions needed to pay for qualified higher education expenses. The payment for education for you, your spouse, or your child or grandchild also avoids the 10% penalty. The funds must be for a college, university, or vocational school. Qualified education expenses include tuition, fees, books, supplies, equipment, and room and board (room and board only applies to a student if they are at least half-time). Only out of pocket expenses can be used -- in other words, the eligible amount will be reduced by scholarships, grants, and employer tuition assistance.
The substantially equal periodic payout strategy
If you don’t fit into any of the exceptions that were previously outlined, you still will be entitled to avoid the 10% penalty if you use the substantially equal periodic payout strategy. This opportunity applies to IRAs, SEPs, and SIMPLEs, and all employer qualified plans. The general rule requires the distribution be “part of a series of substantially equal periodic payouts made at least annually over the life expectancy of the taxpayer”. In addition, qualified plan and 403(b) plan participants must be separated from service.
There are three permissible ways to implement this strategy. Under the required minimum distribution method annual payments are re-determined each year and usually go up. However, in many instances you will be forced to take out less money under this method, and for this reason it is often preferred. Under the amortization method the annual payment is the same every year. The third method is the annuity method. Under this method the annual payment is the same every year, but it is different than the amortization amount. No matter what method is used:
• Payments can begin at any age
• Withdrawals must be made at least annually (or more often)
• A one-time election can be made to change from the amortization method or annuity method to the RMD method (this is generally a way to reduce the required withdrawals).
Even though the Code Section says that payments must continue “over a lifetime”, in actual application withdrawals may be terminated without penalty as long as they last the later of:
– Five years from the date the withdrawals begin
– Age 59½
For example, if your client Tabitha starts distributions at age 40, she can stop distributions at age 59½. If, however, she starts distributions at age 57 she must wait until age 62 to stop distributions.
There are other exceptions to the 10% penalty that don’t come up as frequently. They apply to distributions attributable to an IRS levy of funds, distributions taken by qualified reservists who are called to active duty, distributions needed to pay for health insurance premiums by an unemployed person, distributions occurring because of a divorce (so-called QDRO distributions) and distributions that are rolled over (e.g., Tim withdraws funds from his individual retirement account for personal use and then redeposits them within 60 days).
One important consideration has been stated several times -- even though you avoid the 10% penalty you probably will not avoid extra ordinary taxes on the distribution.
A second important consideration is that you should avoid taking a distribution for frivolous reasons. In light of the pandemic and the personal financial havoc it wreaks, financial planners may acknowledge that withdrawals may be needed. But no financial planner should let you take a withdrawal without illustrating the consequences to your retirement plan. Thoughtful consideration should be given to the impact on future savings. If, however, your situation calls for a plan withdrawal, care should be taken to avoid the 10% penalty for premature withdrawals taking into consideration the possibilities described above. Kenn Tacchino, www.marketwatch.com, June 23, 2020.
15. DEFUND THE POLICE, CUT PENSION LIABILITIES? THE ONE WEIRD TRICK THAT JUST MIGHT WORK FOR CHICAGO:
Minneapolis wants to dismantle its police department. CNN reported, “Nine members of the Minneapolis City Council announced they intend to defund and dismantle the city's police department following the police killing of George Floyd.”
What exactly that means, and how that might play out, as CNN clarifies, and the Minneapolis Star Tribune fleshes out, is far from clear, as “defund” advocates want to prioritize social services but the city’s charter actually requires that it fund a police force.
Separately, Chicago Mayor Lori Lightfoot announced a 90-day reform initiative. Turns out, the city was already supposed to have reformed its police department as a result of a consent decree in the aftermath of the Laquan McDonald shooting in 2014 -- but city officials learned that implementing reform in the face of resistance and bureaucracy is actually harder than it looks. In particular, as Ed Bachrach and Austin Berg note in a Chicago Tribune commentary, that consent decree, and the disciplining of police officers in general, were made subordinate to police union collective bargaining agreements.
But it turns out there is a useful model for successful “defund the police” reform: the city of Camden, New Jersey, in which their police department was so irredeemable dysfunctional, not in terms of police brutality/racism but in their competence in basic police work, that it was indeed shuttered -- not to leave its residents at the mercy of criminals, but with the county taking over policing duties.
Is this the right model for cities where prior attempts at reform have failed? I can hardly answer that question - not with any particular expertise. But I nonetheless asked myself, “what would happen to pensions if the city of Chicago followed that same model?” Of course, that would be contingent on Cook County being able to step in as a more competent successor entity, but hypothetically let’s imagine that this is true, for the sake of argument.
Now, there are some unique characteristics to pensions in Chicago and Illinois. In the first place, Illinois binds all of its pensions to the requirement that they be “neither impaired nor diminished” and the state Supreme Court has ruled that this requirement is very broad, encompassing future as well as past accruals, retiree medical benefits and any form of benefit related to retirement.
In addition, most pension plans in Illinois have reciprocal agreements: individuals who move between the Chicago Teachers’s Pension Fund and the Teachers’ Retirement System, for example, can use their total years of service to qualify for benefits and have their highest average pay from either system used to calculate benefits from both systems. The same is true for Chicago and Illinois municipal workers, state employees, university employees, Cook County workers and miscellaneous Illinois public employees.
But neither the police and fire plans for the city of Chicago, nor those plans for other Illinois municipalities, are included in these reciprocity agreements.
What’s that mean? If the Cook County Sheriff’s Office took over policing in the city of Chicago, then, logically enough, no police officers would be employed by the Chicago Police Department, because it wouldn’t exist any longer.
That doesn’t mean that cops and retired cops would lose their pensions -- the city of Chicago would still be liable. But for currently employed cops, they would only be liable for a “frozen” benefit -- that is, based on their salary at the time of the take-over, without the benefit of the pay increases they would have gotten up to retirement, and without any service-based benefit improvements (such as early retirement benefits) that they would have earned in the future. In the private sector, this would be called a “curtailment,” because, logically enough, benefits were curtailed.
How much would that cut liabilities? Here are the basic numbers, at year-end 2019 (I don’t wish to hazard a guess as to the post-covid-crash values):
Assets (market value, not smoothed): $3,162 million
Liability: $14,270 million.
Funded status: 22%.
The liability splits out into $5,725 million for active employees, and $8,931 for inactive participants (retirees, survivors of deceased employees, and vested terminations).
So what happens if the liability for the active police drops by, say, one-third due to these curtailment effects? The new funded status would be -- are you ready for it? -- 25%.
Why such a small impact? That’s because the inactives’ liability makes up such a large fraction of the total -- 65%. But at the same time, in terms of actual dollars saved, it would work out to $1.9 billion. Turns out, that’s more than the entire CPD spends in a year, which amounts to $1.78 billion -- but, of course, this would be a one-time reduction rather than an annual savings.
To be clear, this is a result that’s somewhat unique to Chicago. Most states’ police pensions are a part of a larger pension system, so that none of the above is relevant to them -- for example, in Minneapolis, police officers participate in the PERA Police and Fire Plan alongside all other Minnesota pubic safety workers.
And, considering the bigger picture, actuary Mary Pat Campbell crunches the numbers and concludes that the chorus calling for the cutting of police department spending and reallocating the savings to social services misses the fact that, as a percentage of total state and local spending, police spending amounts to only 4% of the total. Her data source also reports that public welfare spending (e.g., Medicaid) amounts to 22%; elementary and secondary education, 21%; and higher education and health/hospitals, 10% each.
So nothing’s simple, and the impact of reform on police pensions -- or, to the contrary, the impact of police pensions on the effectiveness of intentions to reform -- is only a small tangent in a bigger story, but, as an actuary, it’s an interesting wrinkle nonetheless. Elizabeth Bauer, Forbes, www.forbes.com, June 8, 2020.
16. SHOPPING ONLINE? WATCH THIS VIDEO FIRST:
In this age of social distancing, more and more of our favorite stores now offer ways to score great deals online. Even as shops around the country open their doors again, buying online is still a great, useful tool for people to enjoy. It’s nice to know that with a simple web search, you can find, buy, and ship almost any item right to your front door. But, while you’re enjoying that convenience, you want to be sure that sharing your financial and personal data online is safe.
Before you click “Place Order,” watch this video to learn some useful tips on how to keep your data secure and save money as you shop.
Looking to learn more? Go to the FTC’s Shopping Online webpage to find out other important ways to protect yourself -- and your wallet -- online. You can also visit ftc.gov/OnGuardOnline for additional tips on how to avoid hackers and scammers while shopping online. Jabari Cook, Intern, Division of Consumer & Business Education, FTC, www.ftc.gov, June 26, 2020.
17. DID YOU KNOW ALBERT EINSTEIN SAID THIS?:
"Logic will get you from A to B. Imagination will take you everywhere."
18. INSPIRATIONAL QUOTE:
"Things work out best for those who make the best of how things work out." -John Wooden
19. TODAY IN HISTORY:
On this day in 1776, Continental Congress resolves "these United Colonies are and of right ought to be Free and Independent States", and in 1964, US President Lyndon B. Johnson signs Civil Rights Act and Voting Rights Act into law.
20. REMEMBER, YOU CAN NEVER OUTLIVE YOUR DEFINED RETIREMENT BENEFIT.