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Miami

Cypen & Cypen
NEWSLETTER
for
DECEMBER 27, 2007

Stephen H. Cypen, Esq., Editor

1. GAO FINDS SOME PROGRESS ON U.S. GOVERNMENT’S FINANCIAL STATEMENTS (BUT SIGNIFICANT PROBLEMS REMAIN):

For the eleventh year in a row, the U.S. Government Accountability Office was prevented from expressing an opinion on the consolidated financial statements of the U.S. Government -- other than the Statement of Social Insurance -- because of serious material weaknesses affecting financial systems, fundamental record keeping and financial reporting. The Comptroller General of the United States, who heads GAO, did note some progress in this year’s audit. This year GAO expressed an unqualified opinion on the fiscal year 2007 Statement of Social Insurance, which includes Social Security, Medicare, Railroad Retirement and Black Lung programs. This statement is significant because it covers some of the largest numbers in the federal government, tens of trillions of present-value dollars associated with future Social Insurance expenditures. Overall, however, the comptroller was not satisfied. In a recent speech at the National Press Club, he said “if the federal government was a private corporation and the same report came out this morning, our stock would be dropping and there would be talk about whether the company’s management and directors needed a major shake-up.” Despite improvements in financial management since the U.S. Government began preparing consolidated financial statements over a decade ago, three major impediments prevent the U.S. Government from attaining a clean opinion: (1) serious financial management problems at the Department of Defense, (2) the federal government’s inability adequately to account for and reconcile intragovernmental activity and balances between federal agencies and (3) the federal government’s ineffective process for preparing the consolidated financial statements. (Yikes.)

2. HOW TO GET AROUND FDIC LIMITS:

With problems cropping up in so many financial institutions, investors with large deposits need to be especially careful, according to TheStreet.com But what if you have deposits that exceed the Federal Deposit Insurance Corp.’s standard $100,000 limit? The obvious solution is to spread your deposits across accounts at different institutions, but doing so can quickly become a record-keeping nightmare, not to mention the hassle of dealing with numerous banks. A relatively new service, Certificate of Deposit Account Registry Service, or “CDARS,” can do this for you. The service, provided by Promontory Interfinancial Network, has been available for about five years. Approximately 1,825 banks and thrifts in all fifty states offer the service, which allows CD depositors with balances of up to $50 Million to have their entire balances insured by FDIC. Here’s how CDARS can work for someone with a $1 Million CD. First, you go to a participating bank or savings and loan (“lead bank”), and fill out an account application and a CDARS agreement. The lead bank acts as account custodian, and, through CDARS, spreads your deposit over 11 FDIC-insured institutions, making sure you have less than $100,000 in each. The lead bank will assign you one account number and send you a single account statement showing which institutions are holding the funds. You will receive one 1099 statement for your taxes or other relevant
tax statements for IRA accounts. Bank of New York acts as a subcustodian for the CD account, so that the only institution that has your personal information is the lead bank. CDs are available through the program for terms ranging from four weeks to five years. Interest payments can be made monthly, quarterly, semi-annually, annually or at maturity. Consumers and businesses are not the only ones using CDARS; they are also catching on with municipalities. Promontory Interfinancial Network states that it has hundreds of municipalities investing billions of dollars through CDARS. Depositors using CDARS are not charged fees to open accounts. Participating banks pay a fee to join CDARS, and pay transaction fees to Promontory Interfinancial Network depending on size of the deposits. Like most CD deposits, there are penalties for early withdrawals. For early withdrawals from CDs with maturities of up to 26 weeks, the depositor’s penalty is the interest for the entire period of the CD. For longer-terms CDs, early-withdrawal penalties are generally the interest for half the CD term. Live and learn.

3. PENSION FUNDS HAD BANNER YEAR:

With pension funds making significant gains, fewer large companies face high degrees of financial risk because of pension liabilities, according to a Watson Wyatt analysis of FORTUNE 1000 companies that sponsored defined benefit pension plans in 2006. Despite recent market volatility and asset values and discount rates, pension funds are expected again to fair well when final 2007 numbers are known. Watson Wyatt’s analysis found that pension plan liabilities posed relatively high financial risk for only 8% of FORTUNE 1000 companies with pension plans in 2006, down from 17% in 2003 -- a decline of about half over four years. Companies with moderate or high pension risk may face financial challenges from their pension plan during poor market conditions. About 29% of companies sponsoring pensions have a moderate amount of risk, while the remaining 63% are exposed to relatively low risk levels. The latter group includes some firms -- 11% of FORTUNE 1000 companies that sponsor pensions -- for which pension plans pose no business risk, a percentage that has more than doubled since 2005. Let’s keep up the good work.

4. LOW DC CONTRIBUTION PLAN SAVINGS MAY POSE CHALLENGES TO RETIREMENT SECURITY:

Over the last 25 years, pension coverage has shifted primarily from traditional defined benefit plans, in which workers accrue benefits based on years of service and earnings, to defined contribution plans, in which participants accumulate retirement balances in individual accounts. DC plans provide greater portability of benefits, but shift responsibility of saving for retirement from employers to employees. A recent U.S. Government Accountability Office report addresses the following issues: (1) What percentage of workers participate in DC plans and how much have they saved in them? (2) How much are workers likely to have saved in DC plans over their careers and to what degree do key individual decisions and plan features affect plan saving? (3) What options have been recently proposed to increase DC plan coverage, participation and savings? GAO analyzed data from the Federal Reserve Board’s 2004 Survey of Consumer Finances, the latest available, utilized a computer simulation model to project DC plan balances at retirement, reviewed academic studies and interviewed experts. GAO’s analysis found that only 36% of workers participated in a current DC plan. For all workers with a current or former DC plan, including rolled-over retirement funds, the total median account balance was $22,800. Among workers aged 55 to 64, the median account balance was $50,000, and those aged 60 to 64 had $60,600. Low-income workers had less opportunity to participate in DC plans than the average worker, and when offered an opportunity to participate in a plan, were less likely to do so. Modest balances might be expected, given the relatively recent prominence of 401(k) plans. Projections of DC plan savings over a career for workers born in 1990 indicate that DC plans could, on average, replace about 22% of annualized career earnings at retirement for all workers, but projected “replacement rates” vary widely across income groups and with changes and assumptions. Projections show almost 37% of workers reaching retirement with zero plan savings! Projections also show that workers in the lowest income quartile have projected replacement rates of 10.3% on average, with 63% of these workers having no plan savings at retirement, while highest-income workers have average replacement rates of 34%. An assumption that workers offered a plan always participate raises projected overall savings and reduces the number of workers with zero savings substantially, particularly among lower-income workers. GAO’s findings indicate that DC plans can provide a meaningful contribution to retirement security for some workers, but may not ensure retirement security of lower-income workers. GAO-08-8 (November 2007).

5. CERTAIN PAYMENTS TO DISABLED VETERANS RULED TAX-FREE:

Payments under the Department of Veterans Affairs Compensated Work Therapy (CWT) program are no longer taxable, and disabled veterans who paid tax on these benefits in the past three years can now claim refunds, according to Internal Revenue Service. Recipients of CWT payments will no longer receive a Form 1099 from VA. Disabled veterans who paid tax on these benefits in tax-years 2004, 2005 or 2006 can claim a refund by filing an amended return using IRS Form 1040X. According to the VA, more than 19,000 veterans received CWT in fiscal year 2007. IRS agreed with a U.S. Tax Court decision issued earlier this year, which held that CWT payments are tax-free veterans’ benefits. In so doing, IRS reversed a 1965 ruling, which held that these payments were taxable, and required VA to issue 1099 forms to payment recipients. IR-2007-198 (December 12, 2007).

6. WHY HAVE DEFINED BENEFIT PLANS SURVIVED IN THE PUBLIC SECTOR?:

A new Brief from Center for Retirement Research of Boston College poses that very question. While 401(k)s now dominate the private sector, defined benefit plans remain the norm among state and local governments. Why have public sector employers not shifted from defined benefit plans to 401(k)s like their private sector counterparts? The Brief examines the unique factors affecting the two sectors that may explain their very different patterns of pension coverage. State and local governments have an older, less mobile and more risk-averse workforce, with a higher degree of unionization to press for benefits that satisfy the needs of these workers. The nature of the employer is also fundamentally different. Unlike private sector firms, state and local governments are perpetual entities. They do not disappear -- like many of the large manufacturing firms -- taking their plans with them, and they are much less concerned about financial volatility associated with defined benefit plans. States and localities can also increase required employee contributions to keep the plan’s finances under control. Finally, the public sector has not had comprehensive pension regulations like the Employee Retirement Income Security Act of 2004; the absence of such regulation lowers administrative costs and enables later vesting. All is not quiet in the public sector, however. In the last ten years, states have explored defined contribution plans. A couple of states (Alaska and Michigan) and the District of Colombia now have a defined contribution plan as their basic pension, and a number of others (eight, including Florida) offer employees the option of a defined contribution plan. A future CRR Brief will explore where and why this activity is occurring.

7. CORPORATE PENSION PLANS ARE HEALTHY:

A vast majority of large corporate pension plans are financially healthy, according to a newly-released survey conducted by the Committee on Investment of Employee Benefit Assets, as reported by PR Newswire Association. After three years of consistent contributions and substantial investment gains, the average funded status of plans participating in the 2006 survey was 103%, based on accumulated benefit obligations. CIEBA represents many of the nation’s largest private sector retirement funds, and its members manage more than $1.5 Trillion in retirement assets. The survey covers 112 corporate plan sponsors responsible for management of $966 Billion in defined benefit plan assets and $573 Billion in defined contribution assets. Plans in the survey cover 11.5 million DB plan participants and 5.6 million DC plan participants. Assets in both DB and DC plans increased during 2006 by 9% and 11%, respectively. Plan increases were generally due to strong investment returns. However, 71% of DB plan sponsors in the survey contributed over $27 Billion to their plans. In the DC plan arena, employer and employee contributions per active employee continued to increase. The combined contribution total per employee was $8,150, with employers contributing 29% of the total. Additional survey findings include:

  • Benefit payments totaled $119 Billion in 2006, of which $72 Billion was paid out of DB plans and $47 Billion was paid out of DC plans.
  • DB plan assets were invested as follows: 36% in U.S. equity, 21% in international equity, 29% in fixed income/cash and 14% in other investments.
  • DC plan assets were invested as follows: 39% in diversified (U.S. and international) equity portfolios, 25% in employer stock, 23% in fixed income, 9% in balanced/lifestyle funds and 4% in loans/other options.
  • Eighty six percent of DB assets were actively managed, compared to 52% of DC assets.


8. DAFFY-NITIONS:

Diplomat: A person who tells you to go to hell in such a way that you actually look forward to the trip.

9. QUOTE OF THE WEEK:

“Never give a party if you will be the most interesting person there.” Mickey Friedman

We wish you and yours a very happy, healthy and prosperous New Year!!!!

Copyright, 1996-2007, all rights reserved.

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


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