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Cypen & Cypen
NEWSLETTER
for
OCTOBER 20, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

1. IRS RELEASES PENSION PLAN LIMITATIONS FOR 2006:

On October 14, 2005 Internal Revenue Service issued IR-2005-120, announcing cost-of-living adjustments applicable to dollar limitations for pension plans and other items for tax year 2006. Effective January 1, 2006, the limitation on annual benefits of a defined benefit plan under Section 415 is increased from $170,000 to $175,000. Similarly, the limitation for defined contribution plans under Section 415 is increased from $42,000 to $44,000. And annual compensation limit under Section 401(a)(17) is increased from $210,000 to $220,000. Finally, the limitation on deferrals under Section 457 deferred compensation plans of state and local governments is increased from $14,000 to $15,000. This year is the last one for Economic Growth and Tax Relief Reconciliation Act of 2001 prescribed annual increases in Section 457 plan limits. For 2007, like the other items listed above, there will be adjustments only if inflation produces an amount sufficient to reach the next increment.

2. SOCIAL SECURITY WILL RISE 4.1%!:

Fifty million Americans who receive Social Security will see a 4.1% boost (about $35.00, on average) in their monthly checks next year. Up from a 2.7% increase last year, the latest increase is the largest since 1991. The increase will first apply to December 2005 benefits payable in January 2006. For Old Age Survivors and Disability Insurance, the payroll tax rate will remain at 6.2% up to the Social Security taxable wage base (which will increase from $90,000 to $94,200). The Medicare Part A tax of 1.45% will continue to apply on all wages in 2006.
3. TOP TEN MYTHS OF SOCIAL SECURITY REFORM:

The Center for Retirement Research at Boston College has published a lengthy (and, surprisingly, balanced) scholarly piece entitled “Top Ten Myths of Social Security Reform.” (Unlike myths of Social Security itself, these myths relate strictly to Social Security reform.) By way of introduction, the U.S. Social Security system has been one of the most successful public policy programs in our nation’s history. Established during the Great Depression, benefits provided through Social Security have helped to prevent poverty among millions of Americans after retirement, during periods of disability or after death of a family breadwinner. Unfortunately, the pay-as-you-go financial structure of the system is not well designed to handle the substantial demographic changes underway in the United States. Estimates by the Office of the Chief Actuary of the Social Security Administration indicate that the existing combination of scheduled taxes and scheduled benefits leaves an $11 Trillion hole in the system over an infinite time horizon. As a result, the only way that Social Security can continue to pay currently-scheduled benefits to future generations is to impose an ever-larger tax burden on younger workers. Here are the myths and a short explanation about each:

Myth 1: Social Security is financially sound for “decades to come.” Real economic and fiscal pressure arises from the collision of demographic change and the pay-as-you-go financial structure as early as the year 2008, when as a result of the Baby Boomers starting to claim benefits, Social Security’s cash flow surpluses will begin to decline.

Myth 2: Economic Growth Will Eliminate the Existing Problem. To avoid making politically difficult policy corrections based on the fact that the future might turn out better than expected is unwise. Rather than using the existence of uncertainty as an excuse to avoid responsible policy actions, policymakers should look for ways to reform the Social Security system so that it is more resilient to unexpected demographic and economic shocks.

Myth 3: Social Security is in “Crisis” and Will Not Be There When Today’s Younger Workers Retire. Under intermediate assumptions of the Social Security Trustees, even if policymakers make no changes in the system and Social Security is unable to pay full benefits after the Trust Fund is exhausted, future retirees will still get approximately three-quarters of what is scheduled under current law. So the question facing today’s younger workers should not be “Will I get anything out of Social Security?” but rather “Just how much will I receive when I retire, and how much will I have to pay in taxes before I get there?” And, as part of the current debate, “Will I be permitted to invest part of my contributions in personal accounts?”

Myth 4: Personal Accounts Can Save Social Security without Benefit Cuts or Tax Increases. Although there may be sound economic reasons to support a move to personal accounts, none of the advantages in any way obviate the need for other reforms that reduce long-term expenditures or increase the long-run revenue stream dedicated to Social Security.

Myth 5: Allowing Individuals to Redirect Their Contributions from the Trust Fund to Personal Accounts Will Provide a Higher Rate of Return. Advocates of personal accounts correctly say that investing in stocks can provide a higher expected return than bonds, so long as they acknowledge the increased risk that comes along as part of the package. However, a comparison of stock market rates of return to the internal rate of return on Social Security is not valid, unless the cost of servicing the legacy debt is first netted out of the comparison.

Myth 6: Personal Accounts will Worsen Social Security’s Financial Problem. In truth, personal accounts neither hurt nor help the long-run financial situation facing Social Security.

Myth 7: Personal Accounts Will Cause Benefit Cuts. Personal accounts are a natural candidate to include in a Social Security reform because voluntary accounts have attractive properties that may increase the utility of workers who choose them. If accounts are introduced at the same time that scheduled benefits are reduced or taxes increased, then positive attributes of the accounts may help partially to offset the negatives of the changes that move the system toward sustainability.

Myth 8: Personal Accounts are Risky and the Current System is Safe. First, one of the core principles of reform is that participation in personal accounts be voluntary. Second, many reform proposals allow individuals to choose a portfolio and allocation with which they are comfortable. Third, it is a mistake to treat the existing Social Security system as being free from risk.

Myth 9: Transitioning to Personal Accounts is Too Costly. These “transition costs” are not new costs at all, but rather a retiming of costs that the Social Security system will eventually have to pay anyway. The money flowing into personal accounts will eventually be used to finance future benefit payments, which will reduce the level of benefits that will need to be financed by payroll taxes on future workers.

Myth 10: Social Security Reform is Bad for the Poor/Women/Minorities. It is wrong to assume that the current Social Security system is progressive and that any reformed system would not be. The system can easily be changed to make the degree of redistribution greater than, less than or equal to that of the current system. Broad and simplistic assertions that certain groups will necessarily win or lose by reform are unlikely to withstand careful scrutiny.

The article is not intended to prescribe solutions to Social Security’s funding problem. Rather, the key message is that, regardless of whether or not personal accounts are created within the Social Security system, any reform effort will require changes to both the tax and benefit side of the system’s finances. While analysts may reasonably disagree over the most appropriate method of reform, there should be little disagreement that the system is in need of reform and that acting soon to address the problem is preferable to doing nothing.

4. FLORIDA CORRECTIONAL OFFICER SQUEEZES THROUGH PRESUMPTION LOOPHOLE:

In 2002, the Florida Legislature amended Section 112.18(1), Florida Statues, the so-called heart-lung statute. Two things were changed: One, the presumption was no longer limited to “state” law enforcement officers and, two, correctional officers were added as beneficiaries of the presumption. The statute now provides that any condition or impairment of health of any firefighter, law enforcement officer or correctional officer caused by tuberculosis, heart disease or hypertension resulting in total or partial disability or death shall be presumed to have been accidental and to have been suffered in the line of duty unless the contrary be shown by competent evidence. However, any such firefighter or law enforcement officer shall have successfully passed a physical examination upon entering into any such service as a firefighter or law enforcement officer, which examination failed to reveal any evidence of any such condition. A judge of compensation claims applied the statutory presumption in determining that correctional officer Reese’s hypertension and heart disease were compensable. The Department of Corrections appealed, arguing that Reese had not successfully passed a pre-employment physical that failed to reveal evidence of his ultimately-disabling heart or lung condition. Rejecting the Department’s appeal, the First District Court of Appeal held that although the statute directs that a condition precedent to a firefighter’s or law enforcement officer’s entitlement to the statutory presumption is proof that the firefighter or law enforcement officer successfully passed a pre-employment physical examination revealing no evidence of the later disability, the plain language of the statute does not require a correctional officer to satisfy this condition. (The appellate court also found “this distinction in requisite proofs is not due to mere legislative oversight.” Nevertheless, we seriously doubt that the Legislature really intended to prefer correctional officers over firefighters and law enforcement officers. Let’s face it -- somebody goofed.) Reese had one other hurdle to clear: his case arose prior to the amendment adding correctional officers to the list of employees entitled to the statutory presumption. Finding that the enactment was merely “procedural,” the Court held that a pre-2002 date of accident did not preclude Reese’s entitlement to the statutory presumption in a post-2002 proceeding. State of Florida v. Reese, 30 Fla. L. Weekly D2387 (Fla. 1st DCA, October 11, 2005).

5. RECENT TRENDS IN RETIREMENT PLAN PARTICIPATION AND CONTRIBUTIONS:

From February through May of 2003, the Bureau of the Census collected information about participation in employer-sponsored retirement plans among individuals in more than 29,000 U.S. households. These data are the most comprehensive source of information available on workers’ participation in employer-sponsored retirement plans from a nationally representative sample of American households. A Congressional Research Service analysis showed that :

  • Between 1998 and 2003, the percentage of private-sector workers whose employers sponsored a retirement plan increased from 62% to 64.8%.
  • The percentage of private-sector workers who participated in employer-sponsored retirement plans increased from 43.1% in 1998 to 46.8% in 2003.
  • 56.4% of workers in the private sector worked for an employer that sponsored a defined contribution plan, such as a Section 401(k) plan, in 2003, an increase of 4.1 percentage points over the sponsorship rate in 1998.
  • 41% of private-sector workers participated in Section 401(k)-type plans in 2003, an increase of 5.6 percentage points over the participation rate in 1998.
  • Among workers whose employers offered a DC plan in 2003, 72.6% participated in the plan, an increase of 4.9 percentage points over 1998.

The variables with the strongest positive relationship to likelihood of participating in a plan are length of service with an employer and monthly earnings. Among workers whose employer sponsored a plan, men, those over age 35, married workers, college graduates, full-time workers, home owners, those at small establishments and those who employer contributed to the plan were more likely than others to have participated in a DC plan. Many workers who did not participate in DC plans believed they were ineligible to participate. In 2003, 28% of respondents said they had not worked for their current employer long enough to be eligible, 29% said that they did not work enough hours to be eligible and 9% said that their particular job was not covered by the employer’s plan. In 2003, the median employee monthly salary deferral into Section 401(k)-type plans was $158, or $1,896 on an annual basis. Eighty-five percent of employees deferred less than $500 per month into these plans in 2003. Only 3% of participants contributed $1,000 per month to DC plans, equivalent to the annual maximum of $12,000 in effect during 2003. Among all private-sector workers who participated in DC plans in 2003, the mean total account balance was $34,757 and the median balance was $15,000.

6. UNION ADVANTAGE FOR BENEFITS WIDENS:

According to Labor Research Association, union workers receive employer-paid benefits that far exceed benefits employers provide for nonunion workers, and the union advantage is growing wider. For years, employers have been canceling benefit coverage and shifting more of the remaining costs to workers. Unions have been able to fight off this employer attack on benefits, but nonunion workers have been left with inadequate health care protections and no retirement security. The total union advantage stood at $10.27 per hour in June 2005, with union workers earning an average of $33.42 per hour in total compensation and nonunion workers averaging $23.15, according to the Bureau of Labor Statistics June 2005 survey of employer costs. The value of benefits that union workers receive is double the value for nonunion workers. On average, union workers receive $12.50 an hour in benefits, compared with $6.38 for nonunion workers, according to BLS. The largest differences in union and nonunion benefits occur in the critical areas of health care and retirement benefits. Employers contribute $3.46 per hour for health care benefits for union workers, compared with just $1.42 for nonunion workers. Union workers receive $2.37 an hour for retirement benefits, compared to $.71 for nonunion workers. The BLS survey collects information from 4,560 private-industry companies with 103 million workers. It is by far the most comprehensive and reliable benefit survey available.

7. AN INTRODUCTION TO ALTERNATIVE INVESTMENTS:

What is an alternative investment? Broadly speaking, an alternative investment describes any asset class other than the traditionally managed “long-only” stock and bond portfolio. (Yes, twenty years ago real estate could have been considered an alternative investment.) Today, alternative investments normally refer to private equity, hedge funds and managed futures/commodities. Investing in alternative assets can be difficult. These assets present some unique challenges in terms of investment and legal due diligence, planning and risk controls. However, prudent investments in alternatives may increase total fund diversification and enhance long-term returns. Before making any investments in the asset class, trustees should work with their fund professionals (investment consultants and attorneys) to develop a sound investment policy statement that clearly articulates their fund’s objectives and limitations regarding such assets. Investors should remember the terms “private equity” and “hedge funds” are often used generically and represent a wide range of investments with widely different levels and types of risk and return. Therefore, new investors in these asset classes should perform extensive due diligence and tread carefully. Investors should consider whether the dollar amount of their allocation to alternatives is large enough to achieve significant diversification, and whether they have the expertise and resources to make investments directly in alternative strategies. If not, such investors should consider using a “fund-of-funds” approach. For example, a hedge fund-of-funds is a limited partnership vehicle that in turn makes investments in many individual hedge funds. While fund-of-funds vehicles do introduce another layer of fees, they can provide diversification across many types of strategies and add professional management, due diligence and oversight. This item is a summary of an article in the October 2005 Benefits & Compensation Digest.

8. FREEZE!:

In Stuart, Florida, a 22 year old man was on the run due to a charge of lewd and lascivious battery. He had the bright idea that he could avoid apprehension by ducking into a freezer in a local Winn-Dixie. He actually managed to avoid detection for over 20 minutes. When he was finally removed, however, the so-called “perp-sicle” was quite ready for a nice warm jail cell. Sorry, couldn’t resist. [October 14, 2005 plansponsor.com NewsDash]


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


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