Archives: Articles

IssueM Articles

The Inherent Risk of High-Priced Assets

Although the United States economy is in good shape—with essentially full employment and an inflation rate close to 2%—a world of uncertainty makes it worthwhile to consider what could go wrong in the year ahead. After all, if the US economy runs into serious trouble, there will be adverse consequences for Europe, Japan, and many other countries.

Economic problems could of course originate from international political events. Russia has been acting dangerously in Eastern and Central Europe. China’s pursuit of territorial claims in the East and South China Seas, and its policies in East Asia more generally, is fueling regional uncertainty. Events in Italy could precipitate a crisis in the eurozone.

But within the US, the greatest risk is a sharp decline in asset prices, which would squeeze households and firms, leading to a collapse of aggregate demand. I am not predicting that this will happen. But conditions are becoming more dangerous as asset prices rise further and further from historic norms.

Equity prices, as measured by the price-earnings ratio of the S&P 500 stocks, are now nearly 60% above their historical average. The price of the 30-year Treasury bond is so high that it implies a yield of about 2.3%; given current inflation expectations, the yield should be about twice as high. Commercial real-estate prices have been rising at a 10% annual pace for the past five years.

These inflated asset prices reflect the exceptionally easy monetary policy that has prevailed for almost a decade. In that ultra-low-interest environment, investors have been reaching for yield by bidding up the prices of equities and other investment assets. The resulting increase in household wealth helped to bring about economic recovery; but overpriced assets are fostering an increasingly risky environment.

To grasp how risky, consider this: US households now own $21 trillion of equities, so a 35% decline in equity prices to their historic average would involve a loss of more than $7.5 trillion. Pension funds and other equity investors would incur further losses. A return of real long-term bond yields to their historic level would involve a loss of about 30% for investors in 30-year bonds and proportionately smaller losses for investors in shorter-duration bonds. Because commercial real-estate investments are generally highly leveraged, even relatively small declines in prices could cause large losses for investors.

The fall in household wealth would reduce spending and cause a decline in GDP. A rough rule of thumb implies that every $100 decline in wealth leads to a $4 decline in household spending. The return of asset prices to historic levels could therefore imply a decline of $400 billion in consumer spending, equal to about 2.5% of GDP, which would start a process of mutually reinforcing declines in incomes and spending leading to an even greater cumulative impact on GDP.

Because institutional investors respond to international differences in asset prices and asset yields, the large declines in US asset prices would be mirrored by similar declines in asset prices in other developed countries. Those price declines would reduce incomes and spending in other countries, with the impact spread globally through reduced imports and exports.

I must emphasize that this process of asset-price declines and the resulting contraction of economic activity is a risk, not a prediction. It is possible that asset prices will come down gradually, implying a slowdown rather than a collapse of spending and economic activity.

But the fear of triggering a rapid decline in asset prices is one of the key reasons why the US Federal Reserve is reluctant to raise short-term interest rates more rapidly. The Fed increased the overnight rate by just 0.25% in December 2015 and is likely to add just another 25 basis points in December 2016. But that will still leave the federal funds rate at less than 1%. With the inflation rate close to 2%, the real federal funds rate would still be negative.

Market participants are watching the Fed to judge if and when the process of interest-rate normalization will begin. Historical experience implies that normalization would raise long-term interest rates by about two percentage points, precipitating substantial corrections in the prices of bonds, stocks, and commercial real estate. The Fed is therefore trying to tamp down expectations concerning future interest-rate levels, by suggesting that changes in demography and productivity trends imply lower real rates in the future.

If the Fed succeeds, the decline in asset prices may be diminished. But the danger of sharp asset-price declines that precipitate an economic downturn should not be ignored.

© 2016 Project Syndicate.

Eleven firms, and their new DOL-related policies

How 11 Brokerages, Wirehouses and Insurers Are Adapting to the DOL Fiduciary Rule

LPL. In May, the independent broker-dealer moved to standardize commissions on variable annuities at 5.5% for most contracts, and by the start of 2017, cap commissions on mutual funds at 3% to 3.5% and pay brokers a standard 0.25% trail fee. The firm will also standardize commissions for non-traded real estate investment trusts and certain insurance products.

Great American Life. In August, Great American, the third-ranked seller of fixed indexed annuities, introduced a zero-commission FIA with a living benefit rider for retirement clients of fee-based broker-dealer advisors and registered investment advisors. The Index Protector 7 offers higher caps on its point-to-point index crediting method—up to 6% compared with 3% to 4% cap on similar products.  

Edward Jones. On August 17, the broker-dealer said it would stop selling mutual funds on commission to retirement investors and reduce investment minimums on fee-based accounts to make them more attractive to IRA investors.

State Farm. Starting in April 2017, State Farm will only sell and service mutual funds, variable products and tax-qualified bank deposit products through a self-directed customer call center.

Jackson National. In September, Jackson National Life, the largest seller of variable annuities in the U.S., launched its first fee-based VA, Perspective Advisory. It offers the same investments and benefit options as Jackson’s top-selling commission-based VA, Perspective II.

Nationwide. On September 26, the Columbus, Ohio-based insurer announced its purchase of Jefferson National Life, an issuer of flat-fee, no-commission variable annuities aimed at the RIA and fee-based advisor market.

Merrill Lynch. On October 6, the unit of Bank of America announced that after April 10, 2017, its IRA account owners will not be able to pay for trades on a commission basis. Their accounts will be assessed a percentage of assets. Brokers may reduce the fee ratio for those who trade but don’t need full services.

Commonwealth. On October 24, Commonwealth Financial Network said its advisors would stop offering commission-based products in IRAs and qualified retirement plans as of April 10, 2017.

Morgan Stanley. On October 26, the wirehouse announced that, in contrast to Merrill Lynch, it would keep its commission-based IRA business when the fiduciary rule takes effect next year. Its advisors will use DOL’s Best Interest Contract (BIC) exemption when charging commissions on transactions involving tax-deferred assets.

Ameriprise. On October 26, Ameriprise, like Morgan Stanley, said it would continue offering commission-based transactions on IRA accounts and use the BIC exemption, adding that it might reduce the breadth of commission-paying investment options offered to retirement investors.   

Raymond James. On October 27, the broker-dealer, which has both independent advisors and employee-advisors, said it would continue offering commission-based transactions on IRA accounts and use the BIC exemption, like Ameriprise and Morgan Stanley.

© 2016 RIJ Publishing LLC. All rights reserved.

Investors not applauding Genworth sale to China Oceanwide

China Oceanwide Holdings Group Co., Ltd., a Chinese company, has agreed to buy all of the outstanding shares of Genworth Financial for about $2.7 billion, or $5.43 per share, according to a release this week. The acquisition will be completed through Asia Pacific Global Capital Co. Ltd., a China Oceanwide’s investment platform.

Genworth shares sold for as much as $36 in mid-2007 and for less than $1 in early 2009, at the post-crash market bottom. The share price recovered to over $18 by May 2014 but fell steadily to as little as $1.70 last February.

Shareholders, who have been stewing for months over Genworth’s debt load, reacted to the deal by selling Genworth stock. The share price fell almost 4%, to $4.26, in early trading on October 27.

Beijing-based China Oceanwide is a privately held, family-owned holding company founded by Lu Zhiqiang. It has operations in financial services, energy, culture and media, and real estate assets globally, including the U.S., with about 10,000 employees.

The transaction is subject to approval by Genworth’s stockholders as well as other closing conditions, including the receipt of required regulatory approvals.

China Oceanwide will also give Genworth $600 million to settle debt maturing in 2018, on or before its maturity, and provide $525 million of cash to the U.S. life insurance businesses. This contribution is in addition to $175 million of cash previously committed by Genworth Holdings, Inc. to the U.S. life insurance businesses.

Separately, Genworth also announced preliminary charges unrelated to this transaction of $535 million to $625 million after-tax associated with long term care insurance (LTC) claim reserves and taxes.

The announcement of those intended charges, along with the acquisition by China Oceanwide as well as Genworth’s risky concentration in the uncertain long-term care insurance market, caused A.M. Best to downgrade several of Genworth’s ratings and place the company and its subsidiaries under review with “negative implications.”

Genworth needed to restructure its U.S. life insurance businesses by “unstacking” Genworth Life and Annuity Insurance Company (GLAIC) from under Genworth Life Insurance Company (GLIC) and to address its 2018 debt maturity. The $1.1 billion infusion from China Oceanwide will help it do that, the release said.   

A Genworth spokesperson shed light on what “unstacking” means in this context. “Separating GLAIC from GLIC is one of the steps Genworth is taking to isolate the LTC downside risk that is pressuring its holding company and subsidiary ratings.  It also will allow any future dividends from the Life and Annuity company to be paid directly to the holding company, which currently is impeded by the legal entity organization,” she told RIJ.

A.M. Best has downgraded the Long-Term Issuer Credit Rating (Long-Term ICR) to “bbb” from “bbb+” and affirmed the Financial Strength Rating (FSR) of B++ (Good) of Genworth Life and Annuity Insurance Company. A.M. Best also downgraded the FSR to B (Fair) from B++ (Good) and the Long-Term ICRs to “bb+” from “bbb” of Genworth Life Insurance Company and Genworth Life Insurance Company of New York. Additionally, A.M. Best downgraded the Long-Term ICRs to “bb-” from “bb+” of Genworth Financial, Inc. and Genworth Holdings, Inc., as well as their existing Long-Term Issue Credit Ratings by two notches. A.M. Best has placed all Credit Ratings under review with negative implications.

In another development, a Louisiana law firm is investigating the Genworth sale on behalf of its shareholders to determine if the China Oceanwide’s $5.43 per share offer undervalues the company or not. The firm, Kahn Swick & Foti, includes former Louisiana attorney general Charles C. Foti, Jr.

Genworth, once part of GE Capital, would be a standalone subsidiary of China Oceanwide. Genworth’s day-to-day operations are not expected to change. Its senior management team will continue to lead the business from its Richmond, Va., headquarters. The insurer will maintain its existing businesses, including its MI businesses in Australia and Canada.

“Genworth will also continue to focus on its key operational priorities, most notably executing its multi-year LTC rate action plan, which is essential to stabilizing the financial position of the legacy LTC business. China Oceanwide has no current intention or future obligation to contribute additional capital to support Genworth’s legacy LTC business,” the release said.

The transaction, which both companies’ boards have approved, is expected to close by the middle of 2017, subject to approval by Genworth’s stockholders and closing conditions, including regulatory approvals. Goldman, Sachs & Co. and Lazard are advising Genworth. Citi and Willis Capital Markets & Advisory are advising China Oceanwide.    

© 2016 RIJ Publishing LLC. All rights reserved.

High stock valuations reduce insider-buying, buybacks: TrimTabs

The purchase by corporate executives of their own firms’ stock—aka “insider buying”—dropped to just $110 million in the first three weeks of October through Friday, according to TrimTabs’ review of Form 4 filings with the Securities and Exchange Commission.  

“The best-informed market participants seem unenthusiastic about U.S. stocks at current prices,” said David Santschi, CEO at TrimTabs Investment Research. “Insider buying is running at the slowest pace for October in the past five years.”

“The pullback in buying by both insiders and companies isn’t an encouraging sign for U.S. equities,” Santschi added.  “Corporate America seems to be battening down the hatches.” TrimTabs Asset Management, a sister company, offers funds that pick stocks on the basis of their liquidity, or the supply and demand for their shares, rather than their fundamental value.

In a research note, TrimTabs explained that the weakness in buying is not just seasonal.  On the first 15 trading days of October, insider buying was $390 million in 2012, $360 million in 2013, $540 million in 2014, and $260 million in 2015.

Share repurchasing programs have also slowed. Stock buyback announcements fell to a nine-quarter low of $115 billion in the third quarter of 2016, and would have been much lower without Microsoft’s single $40 billion buyback. Buybacks have totaled just $8.2 billion in October, as of Friday, October 21.

© 2016 RIJ Publishing LLC. All rights reserved.

TIAA survey shows popularity of closed-end funds

Closed-end funds can bolster the income of people who are in or near retirement and help offset today’s low-interest rate environment, according to 85% of financial advisors surveyed recently by Nuveen, a unit of TIAA Global Asset Management.

Two-thirds of advisors surveyed now use closed-end funds compared with just over half (51%) in 2013, Nuveen found in September. They do so to increase income (58%) and to diversify income (53%)  

Nearly two-thirds (62%) of advisors recommend increasing closed-end fund allocation at retirement to diversify income. About one-third recommend using closed-end funds to take advantage of modest amounts of leverage and to boost returns without changing the risk composition of an investor’s portfolio.

Clients in or near retirement are extremely concerned about protecting principal (73%) and covering health-care costs (72%), about three-quarters of advisors told Nuveen. About two-thirds of advisors said that closed-end funds can increase cash flow and are appropriate for long-term investors.

Dubick & Associates conducted the survey for Nuveen last April using a sample of 326 advisors from the Discovery Database. Advisors were employed by wirehouses, regional broker/dealers, independent broker/dealers, registered investment advisors, banks and insurance companies.  

© 2016 RIJ Publishing LLC. All rights reserved.

A Word to the Wise Advisor

In a financial world that’s shifting from commissions to fee-based compensation, how will advisory firms deal with the fact that most clients don’t like the word “fees”?

As broker-dealers scramble to adapt to the Department of Labor’s new fiduciary rule over the next six months, one challenge will be to teach thousands of advisors how to explain the effect of the new rule on, among other things, fees—a topic that increasingly concerns investors.

“There will be more conversations about fees,” Invesco Consulting’s Gary DeMoss of told hundreds of mainly sell-side executives at the Money Management Institute’s 2016 Fall Solutions conference in Boston this week. “It’s an awkward conversation to have, but your clients will want to hear it from you first.

“You must explain the ‘what’ of DOL, the ‘why’ of DOL, and how it will impact them. Make it about them and how it’s beneficial for them,” DeMoss said. He drew a ripple of laughter from the audience when he warned them not to say, “I must put now put your interests ahead of mine. Bummer.”

The MMI membership consists of asset managers, broker-dealers, TAMPs (turnkey asset management programs), and technology and solutions providers. The audience at the conference was mainly sales and marketing executives and others on the product and distribution platform side of the investment business. 

Laughter was not abundant at the conference. Manufacturers and distributors of mutual funds face significant disruption by the DOL rule, as the brokerage industry shifts toward the sale of institutional share-class funds, index funds and exchange-traded funds by fee-based advisors.

Simultaneously, it is shifting away from the actively managed funds that for years have produced commissions for advisors and provide revenue-sharing dollars for broker-dealers. Broker-dealers are also expected to vastly reduce the number of fund offerings on their shelves.  

In a separate presentation at the conference, A.T. Kearney predicted that the U.S. financial services industry will lose about 6.7% of its $300 billion in revenues over the next five years—much of which will come at the expense of the wealth management businesses of the four so-called wirehouses: UBS, Wells Fargo, Bank of America/Merrill Lynch and Morgan Stanley.   

As one broker-dealer executive put it, “For the last several years, advisors have been moving money out of higher cost shares into institutional shares that pay less or no revenue sharing.  The move to ETFs is doing the same thing.  The DOL rule will only accelerate that. I think everyone agrees that eventually revenue sharing will go away—at least in its current form.  The question for each firm is how will they transition to this.”

Part of that transition will involve training advisors to explain the changes to clients, most of whom don’t know how much they’re currently paying in fees. The explanation may include the news that the client is being moved from commission-based compensation to fee-based or to an automated digital advice platform.

To help companies solve this communication problem, Invesco Consulting hired Maslansky + Partners, a firm once associated with political-linguistic guru Frank Luntz. The firm studies how people understand specific words and messages. It pioneered “Live Instant Response Dial” focus groups, where participants indicate their reactions to a speech that’s in progress.

“There will be more conversations about fees and we need to be doing it the right way,” DeMoss said. It’s essential, he said, for the advisor to know exactly what and how each client is paying for services; otherwise, the advisor will look bad. Firms that try to avoid talking about the DOL are making a mistake, he added: “Anything unexplained or unexpected will be a problem down the road. Don’t leave anything out there for clients to find out about on their own.”

The word “fees” is itself problematic. During Invesco focus groups, people were asked to name the word they liked least: fees, charges, costs or commissions. “Costs” and “charges” were neutral words, with only 6% and 15% of people objecting to them, respectively. “Commissions” was liked least by 26%, but 53% of the group members liked “fees” the least. 

There was some question about whether most clients know what “fee-based” compensation means. DeMoss believes that clients know that it means a percentage of assets under management and that “fee-based” never includes commissions. [“Fee-based” advisors do accept commissions, if properly licensed, according to Yahoo finance.

In Maslansky focus groups, people were also asked which type of account sounded most appealing to them. The overall answer was “flat-fee” accounts, with a 44% share of the vote. “Fee-based” came in second at 35%, followed by “advisory” accounts and “level-fee” accounts. There was a question whether clients believed that flat-fee believed that it meant a fixed dollar amount or a fixed percentage of assets.

Focus group participants were also asked which would bother them more—news that they would incur “unexpected fees” or that their portfolios had “underperformed.” By a roughly two-to-one margin, respondents said they would rather hear about underperformance than new fees. When asked whether they would rather have 8% returns and a non-attentive advisor or 6% returns and an attentive advisor, 69% chose the latter.

Going forward, advisors will need to be upbeat without raising client expectations too high. “Talk about the benefits of the DOL rule and then talk about what it is. Make it all about the client and how it will help them.” Advisors should make a habit of using the word “you” and not the word “I,” DeMoss said.

“Fear-based selling is out,” he told the audience. “So are pretty models, impressive mansions and superlatives about performance potential. Blaming the government doesn’t work. Clients don’t want to hear bashing.” Above all, simplify the process, no matter how difficult that may be. “It’s easy to make investing look hard,” he added. “It’s hard to make investing look easy.”

© 2016 RIJ Publishing LLC. All rights reserved.

Could your job vanish after November 8? Here’s a remedy

Where risk appears, insurance follows. Great American Insurance Group, recognizing the possibility for economic chaos after an election whose outcome one candidate has not promised to accept, is offering supplemental unemployment insurance to executives who think their jobs may soon vanish.

The product is called IncomeAssure.

“As we enter the final stretch of the presidential campaign, economists are increasingly alarmed that the economy may suffer a massive post-Election Day hangover that could impact jobs and income,” said a Great American press release.

“Given the intense dislike each side feels for the opposing candidate, it’s highly doubtful we can look forward to much ‘comfort level’ regardless of who is elected — which is why workers are wasting no time signing up for IncomeAssure.”

The product combines with state unemployment benefits to provide policyholders with up to 50% of their former weekly salary should they become involuntarily unemployed. People who are unexpectedly laid off quickly discover that state unemployment insurance alone won’t cover mortgage payments, tuition, medical bills, or most household expenses, the release said.

“Rather than a state benefit that can be capped at $300 a week,” said David Sterling of Sterling Risk, the Woodbury, NY, insurance brokerage that is administering IncomeAssure, “IncomeAssure covers salaries up to $250,000 a year. It allows policyholders to maintain their current lifestyle and pay their bills while unemployed, regardless of which candidate wins the election.”

© 2016 RIJ Publishing LLC. All rights reserved.

Passive equity funds still gaining assets: Morningstar

Active U.S. equity funds continued to lose assets in September, with an estimated $23.6 billion in net outflow. That was slightly less painful than August’s negative $25.4 billion flow, according to Morningstar’s monthly flow report on U.S. mutual funds and exchange-traded funds, or ETFs.

What active funds lost, passive funds largely gained. U.S. equity attracted steady flows on the passive side, with an estimated inflow of $19.3 billion in September, up from August’s $16.4 billion. Net flow for mutual funds is based on the change in assets not explained by the performance of the fund and net flow for ETFs is based on the change in shares outstanding.

Highlights from Morningstar’s report about U.S. asset flows in September:

  • Flows into passive international equity funds slowed to $2.1 billion in September from $6.4 billion in August, a trend driven by falling flows into emerging-markets in recent months.
  • Taxable-bond funds continued their undisputed rule as the category group with the highest inflows in September, with active funds receiving $10.4 billion and passive funds $12.9 billion.
  • The MSCI Emerging Markets Index posted a 1.3% return in September. Flows into emerging-markets funds remained positive, but much lower than in July and August.
  • The top Morningstar category remains unchanged from August: intermediate-term bond. However, intermediate-term bond was joined by the short and ultra-short bond categories on the list of top inflows.
  • The bottom five categories were also little changed from last month, with large growth, world allocation, and Europe stock sustaining the largest outflows. WisdomTree Europe Hedged Equity and its Deutsche counterpart, Deutsche X-trackers MSCI Europe Hedged Equity, continued to suffer outflows.
  • In September, all top 10 providers except Vanguard and State Street, which are known as passive specialists, experienced outflows on the active side.
  • Vanguard continues to be the top passive provider in September with nearly $21.0 billion in inflows. State Street fell to fourth place behind Vanguard, iShares, and Fidelity, with $1.5 billion in inflows.
  • Fidelity continued to receive inflows to its passive products after lowering fees three months ago. However, the company still experienced a $3.4 billion outflow on the active side.
  • Prudential Total Return Bond, an intermediate-term bond fund that carries  a Morningstar Analyst rating of Bronze, emerged as the top-flowing active fund.
  • After garnering an $11.1 billion inflow in July, SPY attracted $600 million in August, which reflects the general trend away from the U.S. market. September’s $1.2 billion outflow could mean that active managers reallocated to other asset classes after temporarily placing assets in SPY.

© 2016 RIJ Publishing LLC. All rights reserved.

Trump, Buffett, and how the wealthy are taxed

The individual income tax has never taxed the very wealthy much. Donald Trump may have claimed huge losses starting in the early 1990s, but, like other rich investors, he wouldn’t have paid much tax regardless. Despite paying some tax, Warren Buffett’s release of his 2015 tax return affirms that conclusion.

There are two major reasons: first, paying individual income taxes on capital income is largely discretionary, since investors don’t pay tax on their gains until they sell an asset. Second, taxpayers can easily leverage capital gains and other tax preferences by borrowing, deducting expenses, and taking losses at higher ordinary rates while their income is taxed at lower rates. Such tax arbitrage is, in part, what Trump did.

To be fair, some, like Buffett, live modestly relative to their means and still contribute most of what they earn to society through charity. Some pay hefty property and estate taxes and bear high regulatory burdens. And salaried professionals and others with high incomes from work, whether wealthy or not, may pay fairly high tax rates on their labor income. Still, there are many ways for the wealthy to avoid reporting high net income produced by their wealth.

The phenomenon is not new. In studies over 30 years ago, I concluded that only about one-third of net income from wealth or capital was reported on individual tax returns. Taxpayers are much more likely to report (and deduct) their expenses than their positive income. In related studies, I and others found that rich taxpayers reported 3% or less of their wealth as taxable income each year.

But your favorite billionaire did not get that way by earning low single-digit returns to his wealth. Buffett’s 2015 adjusted gross income (of $11.6 million) would be around one-fiftieth of one percent of his wealth, which in recent years has been estimated to be near to $65 billion. Yet, over the past five complete calendar years, Buffett’s main investment, Berkshire Hathaway, has returned an average of over 10% annually.

The wealthy effectively avoid paying taxes on those high returns either by never selling assets and thus never recognizing capital gains, deferring income long enough that the effective tax rate is much lower, or by timing asset sales so they offset losses, as Trump likely has been doing to use up his losses from 1995.

When you die, the accrued but unrealized gains generated over your lifetime are passed to your heirs completely untaxed, though estate tax can be paid by those who, unlike Buffett, don’t give most away to charity.

“Tax arbitrage,” the second technique, is simple in concept though complex in practice. It allows an investor to leverage special tax subsidies just as she’d arbitrage up any investment—in this case, to yield multiple tax breaks. If you buy a $10 million building with $1 million of your own money and borrow the other $9 million, you’d get 10 times the tax breaks of a person who puts up $1 million but, because she doesn’t borrow, buys only a $1 million building.

The law limits the extent to which most people can use deductions and losses from one investment to offset income from other efforts, but “active” investors are exempt from most of those restrictions. In real estate it is quite common for the active individual or partner to use the interest, depreciation, and other expenses from a new investment to generate net negative taxable income to offset positive income generated by other, often older, investments.

The main trick is simply to let enough income from all the investments accrue as capital gains. For example, take a set of properties that generate $1 million in rents and $500,000 in unrealized appreciation. If expenses are $1,200,000, net economic income would be $300,000 ($1,000,000 plus $500,000 minus $1,200,000); but net taxable income would be a negative $200,000 ($1,000,000 minus $1,200,000) since the unrealized appreciation is not taxable income.

Real estate owners enjoy other tax benefits as well. They can sell a property without declaring the capital gain by swapping the asset for another piece of real estate—a practice known as a “like-kind” exchange. Often, when a property exchanges hands it ends up being depreciated more than once.

At the end of the day, tweaks to the individual income tax system, including higher tax rates, are unlikely to increase dramatically the taxes paid by the very wealthy. Instead, policymakers need to think more broadly about how estate, property, corporate, and individual income taxes fit together and how to reduce the use of tax arbitrage to game the system.

The Government We Deserve is a periodic column on public policy by Eugene Steuerle. A former deputy assistant secretary of the Treasury, he is an Institute fellow and the Richard B. Fisher Chair at the nonpartisan Urban Institute.

 

Anecdotal Evidence: Football and Financial Ads

It’s football season so I’m catching a few games on TV, which means seeing commercials for financial service providers. E*Trade’s re-“tire”-ment story was the funniest of the lot. A bearded man in a cardigan, slightly resembling Julius Irving and palming a goblet of red wine, addresses the camera from his wood-paneled study, where full-size automobile tires are mounted trophy-style on the walls.

In the space of 15 seconds, he creates about eight or 10 puns using the word “tire” before recommending E*Trade as a retirement partner. If you’re not prepared for it, and you like puns—which E*Trade’s target audience may or may not—it’s unexpectedly funny. That spot was paired with a similar one in which a tailor puns on the word “vest,” as in in-“vest”-ment. There’s also a Benedict Arnold spot that exploits the word “trade” (as in traitor).

For absurdity, these spots almost match GEICO’s recent Marco Polo ad, in which the “real” 14th century Marco Polo wades into a backyard swimming pool and, speaking in Italian, tries unsuccessfully to convince kids who are busy playing “Marco Polo” that the real Marco Polo is right in front of them.

Why anybody would custody his or her retirement savings at a discount brokerage, it’s difficult to say. The biggest joke of all is the one E*Trade plays on its prospects by offering a $600 reward for new signups. You must deposit between $250,000 to $499,999 at E*Trade to qualify for that reward, according to the fine print. Unfortunately, other companies have copied this type of click-bait teaser. The DOL, which now regards rollover recommendations as fiduciary acts, might frown on it. 

*                        *                        *

Pacific Life engaged in a bit of slap-water, if not slap-stick, comedy with a commercial during either the Arkansas-Ole Miss game or the Ohio State-Wisconsin game last Saturday. The 30-second spot featured the montage of PacLife’s trademark humpback whales, breaching, fin-slapping and lob-tailing in the ocean as usual. This time, however, each emphatic slap coincided with the crash of percussion instruments in a marching band. It was an efficient, humorous merger of brand-reinforcement and football.

Northwestern Mutual’s commercial airing last Saturday wasn’t new, but it remains noteworthy for its messaging. The voice-over and graphics emphasize the point that smart retirement planning often requires the use of both investments and insurance products in combination, and that Northwestern Mutual specializes in bringing the two together. I don’t know of any other retirement company that makes that pitch so explicitly. The commercial also depicts a very attractive mixed-race couple. The husband is white, the wife African American. The message may be: We’re a modern, hip company; not the “Quiet Company” your father or grandfather knew.

*                        *                        *

Inside the first section of my Sunday newspaper last weekend, I saw Wells Fargo Bank’s full-page ad. The headline said, “Moving forward to make things right.” This is part of the mega-bank’s damage-control campaign amidst its ongoing 17-month reputational train wreck.

“We have eliminated product sales goals for our Retail Banking team members who serve customers in our bank branches and call centers…, the ad copy said in part. “We have provided full refunds to customers we have already identified and we’re broadening our scope of work to find customers we may have missed.”

Banking services are sticky, Americans have short memories and the strength of the Wells Fargo brand (Boomers may remember the Wells Fargo song from “The Music Man”), so the company may survive its current troubles: the resignation of CEO/chairman John Stumpf, a $185 million federal fine and a 24% decline in its stock price since mid-2015 (when the city of Los Angeles announced its action against the bank for pressuring its employees to create millions of phony new accounts for clients in order to meet aggressive sales goals).

Since the financial crisis, ownership of Wells Fargo stock has made its senior managers and others very rich. Just before the financial crisis, the stock reached a high of $30 before plunging to less than $9 in March 2009. It peaked at almost $58 in mid-July 2015, when Los Angeles announced its action.  

Despite those widely publicized revelations, the bank’s stock held most of its value for another year. As recently as six weeks ago, the share price was $50.55. Then came the Consumer Financial Protection Bureau’s announcement of a $185 million fine in early September. Since then the price has slumped to $44.71 (as of October 14). That, added to Stumpf’s unsatisfying appearance before a Senate committee, forced him to retire.

The drop in the Wells Fargo share price may or may not last, and may depend as much on the impact of the DOL fiduciary rule as on reactions to the phony accounts fiasco. But the incident exemplifies the conflict-of-interest that publicly-held companies inevitably struggle to manage. Their mandate to put shareholders’ interests ahead of customers’ interests can breed incentives that lead to abuse. Such conflicts may become harder to manage, and create new legal exposures, under the DOL rule.  

© 2016 RIJ Publishing LLC. All rights reserved.      

It’s splitsville for MetLife and Snoopy

“MetLife. Navigating life together.”

That’s the official slogan for MetLife’s new “global brand platform.” Beachgoers won’t ever see this new slogan trailing behind Snoopy’s famous Sopwith Camel biplane, because MetLife is ending its 30-year ad partnership with the beloved cartoon beagle and the other Peanuts characters created by the late Charles Schulz. 

“This decision wasn’t taken lightly,” said a MetLife spokesperson. In global surveys, MetLife found that only 3% of institutional and individual customers mentioned the insurer when asked what they associated Snoopy with. Only 18% mentioned MetLife when asked what company they associated Snoopy with.Snoopy in Sopwith Camel

“Snoopy did his job,” the spokesperson said. Clients have always equated Snoopy with friendliness and approachability, which helped MetLife 30 years ago when insurers were seen as remote. Today, MetLife wants to be seen around the world as “forward-thinking” and “trustworthy,” and that’s not exactly how Snoopy is perceived.  

“Customers want something different. They are overwhelmed by all the changes in their lives, and they need someone to help them manage it all. They’re not necessarily looking for a total solution, but they want someone to be there for them throughout their lives,” the spokesperson said, adding that the audience of the new messaging includes both institutional and retail customers. MetLife conducts retail business abroad, but not in the U.S.

 “We are moving away from a traditional product-development model to one driven by customer insights,” said Steven A. Kandarian, chairman, president and chief executive officer of MetLife, Inc. The company said it will “remove the complexities traditionally associated with insurance” and create “simplified interactions” with clients.

MetLife’s new mark is a stylized M with two overlapping half-parabolas, one green and one in MetLife’s trademark blue, which is closer to a Dodger blue than an IBM blue. The corners are rounded and the bullet-shaped overlap is a darker shade of MetLife blue.

“The iconic MetLife blue carries forth the brand’s legacy, but has been brightened and now lives alongside a new color—green—which represents life, renewal and energy. The broader MetLife brand palette expands to include a range of vibrant secondary colors, reflecting the diverse lives of its customers,” the release said.

MetLife will introduce the new brand globally through 2017. The new design system is currently live across mobile, social and web properties. In the U.S., print ads will appear in the Wall Street Journal, New York Times and Washington Post beginning Oct. 21 and new broadcast ads will be on air in December. Additional advertising is running in Mexico, Korea and Japan.

© 2016 RIJ Publishing LLC. All rights reserved.

Honorable Mention

AXA and BlackRock to manage €10bn each for ING pension fund

In the largest institutional contract win in the Dutch market this year, the €26bn closed-end defined benefit pension fund of the ING financial group has outsourced its liability-matching portfolio to AXA and BlackRock, offering each about €10bn, IPE.com reported.

 “Pensioenfonds ING was facing the same material challenges of most Dutch institutional investors in optimally hedging its interest-rate and inflation risks with the fixed income portfolio,” said Hanneke Veringa, head of the client group in the Netherlands for AXA Investment Management (AXA IM).

AXA IM intends to help other institutional investors benefit from its balance sheet management experience, said Julien Fourtou, the firm’s global head of multi-asset client solutions.

“We will further expand this service to those facing similar constraints, where both funding and regulatory objectives must be met in a cost-efficient manner, while ensuring the boards of the pension funds remain in full control,” he said. The ING Pension Fund said it conducted an extensive selection process before signing deals with BlackRock and AXA IM.

The fund’s return portfolio – which focuses on creating an adequate return for pensions indexation – had already been outsourced, ING said. Reporting on the investment and currency risk management is outsourced to the The pension’s treasury portfolio continues to be run by Florint Capital Cardano will handle reporting on the investment and currency risk management. Investment policy will not change, according to ING Pension Fund. 

Pension funds and insurance companies continue to face the challenge of low-yield environment where inflation was low but expected to rise. Last August, the ING Pension Fund said that it would increase its inflation cover to 25% from 8.5% of real liabilities over the next four years, and expand its matching portfolio allocation to 75% from 70%, at the expense of investments in its return portfolio.

Voya, Shlomo Benartzi partner on behavioral economics research

Voya Financial, Inc., has launched Voya Behavioral Finance Institute for Innovation, a research initiative focused on consumer financial decision-making and retirement savings behavior, the company said in a release.

 “The Institute will test a number of novel concepts that could translate into large-scale solutions to help people save more and achieve better retirement outcomes,” the release said. Its work will “merge behavioral science with the speed and scale of the digital world.”

Behavioral economist Shlomo Benartzi, professor and co-chair of the Behavioral Decision-Making Group at UCLA Anderson School of Management, has been engaged as a senior academic advisor, along with John W. Payne of Duke University’s Fuqua School of Business. 

Rick Mason, senior advisor at Voya Financial, will help coordinate the efforts for the company. Research will be conducted in laboratory, panel and field settings and applied at Voya’s plan sponsor clients and distributors. 

The institute’s researchers will examine how to improve outcomes in areas such as savings rates, participation in workplace plans, portfolio diversification, creating sufficient retirement income and preventing so-called leakage from retirement plans, when participants cash out their savings after leaving a job.

The launch of the Voya Behavioral Finance Institute for Innovation included a forum in New York City on Oct. 18, where Nelson and Benartzi joined Voya executives, clients and distributors, along with members of the media, for a discussion on the Institute’s first white paper, “Using Decision Styles to Improve Financial Outcomes – Why Every Plan Needs a Retirement Check-Up.”

The paper, written by Benartzi, examines the two primary decision-making styles—Instinctive and Reflective—that people use. The two styles, which correspond to “fast” and “slow” processes described in Daniel Kahneman’s bestseller, Thinking, Fast and Slow (Farrar, Straus and Giroux, 2011) will help interpret data collected from the online activities of retirement plan participants and can inform a sponsor about the overall “health” of its plan.

Lafayette Life adds Goldman Sachs index option to its FIA

Lafayette Life, a provider of whole-life insurance, annuities and retirement plans and unit of Western & Southern Financial Group, Inc., has enhanced its Marquis SP, a single-premium, deferred, fixed indexed annuity, according to a release.

Lafayette Life has added one- and two-year, point-to-point allocation options associated with the GS Momentum Builder Multi-Asset Class (GSMAC) Index, sponsored by Goldman Sachs. The new options are in addition to Marquis SP’s three-year, point-to-point allocation option associated with the GSMAC Index. 

The GSMAC Index utilizes a volatility-control design. The annuity’s account value can never decline due to index performance, and there is no interest-rate cap or interest-spread fee on the GSMAC index.

Bogle, Hounsell to discuss retirement financing at town hall in Philadelphia

Jack Bogle, founder of the Vanguard Group, will appear in a public town hall discussion in Philadelphia on October 26. The discussion will focus on how Baby Boomers, Gen Xers, and Millennials can better prepare for retirement.

The discussion, to be held at the WHYY radio and television studios, will accompany a screening of “When I’m 65,” a documentary exploring the psychology, sociology, and future of retirement.  It will air on public television station WHYY on Sunday, November 13, at 7:00 PM.

Pennsylvania Secretary of Banking and Securities Robin L. Wiessmann will deliver opening remarks and WHYY’s Mark Eichmann will moderate the discussion of a distinguished panel:

  • Jack Bogle, The Vanguard Group
  • Dr. Andrew Hill, Economic Education Advisor, Federal Reserve Bank of Philadelphia
  • Cindy Hounsell, President, Women’s Institute for Secure Retirement (WISER)
  • Dr. Joseph Friedman, Professor of Economics, Temple University

The town hall is free and will be held at WHYY’s studios, 150 North Street, Philadelphia, on October 26 at 6:00 PM. No tickets are needed; however advance registration is required. Visit www.whyy.org/events. For more information about “When I’m 65,” visit www.wi65.org

The filming of “When I’m 65” was funded by Detroit Public Television, the Investor Protection Trust, the Investor Protection Institute, and the Pennsylvania Department of Banking and Securities.

Lower fund fees at Prudential Investments 

Prudential Investments has reduced expenses for several of its mutual funds, including the Prudential Total Return Bond Fund, with $17.1 billion in net assets. The list also includes the Prudential Global Total Return Fund, Inc.

In the past five years, Prudential Investments has administered several fee reductions, the equivalent of $30.2 million in savings to investors through Aug. 31, 2016.

Prudential Investments is the mutual fund group of PGIM, a top 10 global investment manager with more than $1 trillion in assets under management and the global investment management business of Prudential Financial, Inc. 

PitchBook to be wholly-owned by Morningstar

Morningstar, Inc. has agreed to buy PitchBook Data, Inc., a nine-year-old firm that delivers data, research, and technology covering the breadth of the private capital markets, including venture capital, private equity, and mergers and acquisitions (M&A).

Morningstar invested early in PitchBook and already owns about 20% of the company. PitchBook will maintain its brand and identity and will continue to be led by founder and chief executive officer John Gabbert, according to a Morningstar release.

The company expects to pay approximately $180 million (subject to working capital adjustments) for the remaining ownership interest in a transaction that values PitchBook at $225.0 million.

Morningstar president Kunal Kapoor, a director of PitchBook since 2012, will become chief executive officer of Morningstar effective Jan. 1, 2017.

Data on private capital markets is difficult to find and often in non-standard formats. PitchBook has comprehensive private market datasets and robust research process. PitchBook’s client count has more than tripled over the past three years (to more than 1,800), and sales bookings have grown by a compound annual growth rate of more than 70 percent for the five years ended Dec. 31, 2015.

The company’s PitchBook Platform and user interface allows clients to access data, discover new connections, and conduct research on potential investment opportunities. PitchBook covers the full lifecycle of venture capital, private equity and M&A, including the limited partners, investment funds, and service providers involved. PitchBook will allow Morningstar to apply its core data and software capabilities to private and institutional investors for the first time.

Based in Seattle, PitchBook had $31.1 million in revenue for the trailing 12 months ended June 30, 2016. The company has more than 300 employees located in Seattle, New York, and London. Morningstar originally invested$1.2 million in PitchBook as a Series A Preferred investor in September 2009 and another $10.0 million as a Series B Preferred investor in January 2016. Subject to customary closing conditions, the two companies expect the transaction to close in the fourth quarter of 2016.

© RIJ Publishing LLC. All rights reserved.

The Annuity That Pays for Itself

Annuity purveyors may be excused for feeling criminalized by the federal government these days. The Department of Labor, after all, has made it harder for those selling variable and indexed annuities to IRA owners to accept manufacturer-paid commissions. Slower sales have been predicted in 2017 for both of those products.

On the other hand, there’s one income-generating annuity whose usage the Feds actively encourage: the qualified longevity annuity contract, or QLAC. It lets retirees buy an income annuity at say, age 65, with up to a quarter of their IRA (<$125,000) and defer income (and the federal tax on that income) until as late as age 85 without violating the rules that require IRA withdrawals to begin at age 70½.

You may be thinking: The deferred income annuity already has three strikes against it. As a simple spread product, it’s not profitable enough for publicly held insurers; by reducing assets under management, it reduces the income of fee-based advisors; and, because of its illiquidity, it’s not even popular with retirees. Indeed, few people probably know it exists.

But QLACs have a couple of admirable, and timely, characteristics. Except for clients who have too little money or are in poor health, QLACs are likely to be in a retiree’s “best interest,” and therefore compliant with the new DOL rule. And, as academics have been saying for several years, they allow retirees to spend their non-annuitized money a little more freely.

To understand the logic of QLACs, consider a new academic paper from the National Bureau of Economic Research. Written by Olivia Mitchell of the Wharton School and Raimond Maurer and Vanya Horneff of Goethe University in Frankfurt, Germany, it demonstrates that longevity insurance, as QLACs are also known, can, when used strategically, almost pay for itself. (The authors present the QLAC as a distribution option in a 401(k) plan, but their findings are valid for IRA owners.)

The three economists, who have studied the use of QLACs in Germany and Singapore, where retirees are required to purchase them with part of their tax-deferred savings, described two hypothetical college-educated women, one who bought a QLAC with 15% of her qualified savings at retirement and one who did not.

They found that the woman with the QLAC could afford to save a bit less before retirement, spend between five percent and 20% more during retirement, and probably have much more spending power after age 85 than the person without access to a QLAC.

“Introducing a longevity income annuity to the plan menu is attractive for most DC plan participants who optimally commit 8-15% of their plan balances at age 65 to a LIA that starts paying out at age 85. Optimal annuitization boosts welfare by 5-20% of average retirement plan accruals at age 66 (assuming average mortality rates), compared to not having access to the LIA,” the authors write.

Maurer, in an email exchange with RIJ, acknowledged that the following scenario would provide an approximation of what he and Mitchell found. For example, a single man with a more typical $120,000 IRA could, under the QLAC rules, allocate $30,000 at age 65 to a life-only QLAC paying about $1,200 per month starting at age 85.

Alternately, the same man, seeking the same level of longevity risk protection, could wait until age 85 to buy an immediate annuity. But a life-only annuity paying $1,200 per month for life, purchased at that age, would cost $100,000. The man would have to create a side fund of about $55,000 at age 65 to accumulate $100,000 by age 85, assuming a 3% growth rate.

In other words, the QLAC gives this hypothetical client $25,000 more spending power in retirement (by spending $30,000 on an annuity at age 65 instead of putting $55,000 in a side or “granny” fund). While $25,000 over 20 years might not sound like much—it’s an average of only about $100 per month—it’s enough to finance a fair amount of vacation travel during the so-called “go-go” years (ages 65 to 75).

So, counter-intuitively, the longevity insurance gives the retiree more liquidity in retirement rather than less. Of course, the same individual could simply ignore longevity risk, not set aside any side fund at all and assume that he will die by age 85. But advisors who specialize in retirement income might tend to advise against that.

“This is a nice example which is easy to understand,” Maurer wrote in an email to RIJ this week. The QLAC strategy, the paper notes, works best on average for people with substantial qualified savings, which in many but not all cases means people with higher educational attainment, higher incomes and longer life expectancies.

Maurer, Horneff and Mitchell aren’t the first to observe that by relieving retirees of the duty to hoard their savings against the possibility of living past age 85 and by unlocking the “mortality credits” that accrue to owners of life-only annuities as a result of risk-pooling, deferred income annuities can make retirement more financially comfortable for many people.

To name just a few: Jason Scott of Financial Engines, Wade Pfau of The American College, David Blanchett of Morningstar, Moshe Milevsky of York University, and Jeffrey Brown of the University of Illinois–Chicago, have all contributed to the literature in this area over the past decade.

QLACs have another big advantage that isn’t mentioned in the new paper. By reducing a retiree’s longevity risk, these contracts arguably create more capacity for taking on equity risk with non-annuitized assets. Owning more stocks can protect clients against inflation risk and arguably raises the likelihood of producing a larger legacy.

To be sure, the pros and cons of longevity insurance have been known for some time. But what’s new are the Treasury Department’s exemption of QLACs from RMDs at age 70½ and the DOL’s “best interest” requirement for retirement advisors. Advising clients to allocate part of their IRAs to longevity insurance might be a smart way for advisors and clients to take advantage of one and satisfy the demands of the other.

© 2016 RIJ Publishing LLC. All rights reserved.

The Annuity That Pays for Itself

Annuity purveyors may be excused for feeling criminalized by the federal government these days. The Department of Labor, after all, has made it harder for those selling variable and indexed annuities to IRA owners to accept manufacturer-paid commissions. Slower sales have been predicted in 2017 for both of those products.  

On the other hand, there’s one income-generating annuity whose usage the Feds actively encourage: the qualified longevity annuity contract, or QLAC. It lets retirees buy an income annuity at say, age 65, with up to a quarter of their IRA (<$125,000) and defer income (and the federal tax on that income) until as late as age 85 without violating the rules that require IRA withdrawals to begin at age 70½.

You may be thinking: The deferred income annuity already has three strikes against it. As a simple spread product, it’s not profitable enough for publicly held insurers; by reducing assets under management, it reduces the income of fee-based advisors; and, because of its illiquidity, it’s not even popular with retirees. Indeed, few people probably know it exists.

But QLACs have a couple of admirable, and timely, characteristics. Except for clients who have too little money or are in poor health, QLACs are likely to be in a retiree’s “best interest,” and therefore compliant with the new DOL rule. And, as academics have been saying for several years, they allow retirees to spend their non-annuitized money a little more freely.

To understand the logic of QLACs, consider a new academic paper from the National Bureau of Economic Research. Written by Olivia Mitchell of the Wharton School and Raimond Maurer and Vanya Horneff of Goethe University in Frankfurt, Germany, it demonstrates that longevity insurance, as QLACs are also known, can, when used strategically, almost pay for itself. (The authors present the QLAC as a distribution option in a 401(k) plan, but their findings are valid for IRA owners.)

The three economists, who have studied the use of QLACs in Germany and Singapore, where retirees are required to purchase them with part of their tax-deferred savings, described two hypothetical college-educated women, one who bought a QLAC with 15% of her qualified savings at retirement and one who did not.

They found that the woman with the QLAC could afford to save a bit less before retirement, spend between five percent and 20% more during retirement, and probably have much more spending power after age 85 than the person without access to a QLAC.

“Introducing a longevity income annuity to the plan menu is attractive for most DC plan participants who optimally commit 8-15% of their plan balances at age 65 to a LIA that starts paying out at age 85. Optimal annuitization boosts welfare by 5-20% of average retirement plan accruals at age 66 (assuming average mortality rates), compared to not having access to the LIA,” the authors write. 

Maurer, in an email exchange with RIJ, acknowledged that the following scenario would provide an approximation of what he and Mitchell found. For example, a single man with a more typical $120,000 IRA could, under the QLAC rules, allocate $30,000 at age 65 to a life-only QLAC paying about $1,200 per month starting at age 85.

Alternately, the same man, seeking the same level of longevity risk protection, could wait until age 85 to buy an immediate annuity. But a life-only annuity paying $1,200 per month for life, purchased at that age, would cost $100,000. The man would have to create a side fund of about $55,000 at age 65 to accumulate $100,000 by age 85, assuming a 3% growth rate.

In other words, the QLAC gives this hypothetical client $25,000 more spending power in retirement (by spending $30,000 on an annuity at age 65 instead of putting $55,000 in a side or “granny” fund). While $25,000 over 20 years might not sound like much—it’s an average of only about $100 per month—it’s enough to finance a fair amount of vacation travel during the so-called “go-go” years (ages 65 to 75). 

So, counter-intuitively, the longevity insurance gives the retiree more liquidity in retirement rather than less. Of course, the same individual could simply ignore longevity risk, not set aside any side fund at all and assume that he will die by age 85. But advisors who specialize in retirement income might tend to advise against that.  

“This is a nice example which is easy to understand,” Maurer wrote in an email to RIJ this week. The QLAC strategy, the paper notes, works best on average for people with substantial qualified savings, which in many but not all cases means people with higher educational attainment, higher incomes and longer life expectancies. 

Maurer, Horneff and Mitchell aren’t the first to observe that by relieving retirees of the duty to hoard their savings against the possibility of living past age 85 and by unlocking the “mortality credits” that accrue to owners of life-only annuities as a result of risk-pooling, deferred income annuities can make retirement more financially comfortable for many people.

To name just a few: Jason Scott of Financial Engines, Wade Pfau of The American College, David Blanchett of Morningstar, Moshe Milevsky of York University, and Jeffrey Brown of the University of Illinois–Chicago, have all contributed to the literature in this area over the past decade.

QLACs have another big advantage that isn’t mentioned in the new paper. By reducing a retiree’s longevity risk, these contracts arguably create more capacity for taking on equity risk with non-annuitized assets. Owning more stocks can protect clients against inflation risk and arguably raises the likelihood of producing a larger legacy.

To be sure, the pros and cons of longevity insurance have been known for some time. But what’s new are the Treasury Department’s exemption of QLACs from RMDs at age 70½ and the DOL’s “best interest” requirement for retirement advisors. Advising clients to allocate part of their IRAs to longevity insurance might be a smart way for advisors and clients to take advantage of one and satisfy the demands of the other. 

© 2016 RIJ Publishing LLC. All rights reserved.  

A Tale of Two Tax Plans

Two new Tax Policy Center reports quantify the dramatic contrast between the latest tax plans of Hillary Clinton and Donald Trump. 

Clinton has proposed a significant tax increase on high-income households and businesses. Trump’s plan, while less ambitious than the version he released in 2015, would still largely benefit high-income households and result in a substantial boost in the federal debt. 

The Trump plan

Trump’s latest plan would reduce federal revenues by $6.2 trillion over the next decade, with nearly half of the tax cuts going to the highest-income one percent of households.  Clinton, by contrast, would boost federal revenue by $1.4 trillion over the next decade, with the bottom 80% of households receiving tax cuts and the top one percent paying over 90% of the net tax increase.   

These revenue estimates use traditional budget scoring and exclude macroeconomic effects (dynamic scoring) and changes in interest costs. With added interest, the Trump plan would add about $7.2 trillion to the national debt over the next decade.

Because Clinton’s tax plan would reduce interest costs, it would trim the debt by $1.6 trillion over the next 10 years (though her spending proposals would likely soak up much of that revenue). Tax Policy Center will soon release dynamic scores of both plans, which it produces in collaboration with the Penn Wharton Budget Model.

Under Trump’s plan, households would receive an average tax cut of about $3,000 in 2017, or 4.1% of after-tax income. While all income groups would get a tax cut on average, those in the top one percent would enjoy a tax cut of nearly $215,000—a 13.5% increase in their after-tax income.

Middle-income households would receive a tax cut averaging about $1,000, or 1.8% of their after-tax income and low-income households would get a tax reduction of about $100, boosting their after-tax income by 0.8%. However, some single parents and large families would pay higher taxes under Trump’s proposal than they do today.

Trump would collapse the current seven tax brackets to three—12%-25%-33%. He’d combine the current standard deduction and personal exemptions into a single increased standard deduction of $15,000 for single filers and $30,000 for couples, but eliminate head of household filing status. He’d add a new deduction for child and dependent care, and repeal the alternative minimum tax and the estate tax. He’d also cap itemized deductions and tax capital gains in excess of $5 million at death.

Trump would tax all businesses at a top rate of 15%, repeal the corporate AMT and some business tax subsides, and tax unrepatriated foreign earnings of US-based multinationals at a rate of 10% for cash and 4% for other income.

The Clinton plan

Clinton’s plan is the mirror image of the Trump proposal. She’d raise taxes by an average of about 1.2% of after-tax income in 2017, or $800. However, those in the top one percent would face an average tax hike of 7.4% of after-tax income, or $118,000. She’d reduce taxes for low- and middle-income households by an average of about $100, with those in the bottom 20% getting an average tax cut of 0.7% of after-tax income and middle-income households seeing their after-tax incomes rise by 0.2%.

While Trump often accuses Clinton of raising taxes across-the-board—in Sunday night’s debate he claimed she is “raising everybody’s taxes massively”—the vast majority of households would pay roughly the same amount of federal tax under Clinton’s plan as they do today.

Clinton has proposed new tax credits for some households, such as those with high medical expenses or that are caring for aging parents. Her latest plan also expands the child tax credit. To pay for these and other domestic policy initiatives, she’s proposed a 4% surtax on adjusted gross income (AGI) in excess of $5 million, a new minimum tax on filers with AGI in excess of $1 million, and a 28% cap on the tax benefits from certain deductions and exclusions. She’d also retain the current AMT, raise capital gains taxes for assets less than 6 years, and increase taxes on large estates.

The upshot

While Clinton has made modest changes to her tax platform during the course of her campaign, Trump has significantly revised his proposal since last year. Compared to his initial version, his current plan is about one-third less costly, though it would still add trillions of dollars to the federal debt.

While his first proposal would have reduced taxes by an average of $5,000 and cut overall tax revenues by $9.5 trillion over 10 years, this version would reduce taxes by an average of $3,000, and slash federal revenues by $6.2 trillion. Both plans are similarly regressive.

By themselves, Trump’s tax cuts would increase incentives to save, invest, and work while Clinton’s would discourage those activities at the margin. However, because Trump would increase the federal deficit so much, most, if not all, of the macroeconomic benefits of his tax cuts would be washed away by higher interest rates.

When it comes to taxes, among many other things, voters face a stark choice in November.   

© 2016 Urban-Brookings Tax Policy Center.

Retiring (Temporarily) to Paradise

If you’re an advisor, perhaps a few of your clients have mentioned the possibility of retiring someplace warm, unhurried and inexpensive, like a beach town in Central American. Sounds like bliss, right? Well, yes and no.

Not long ago, through Facebook of course, I contacted a fellow I knew long ago and far away. His passion at the time was composing music, but I didn’t know whether he pursued it or not. At one point, I had heard that he retired early to the tropics. For personal and professional reasons, I wanted to find out how it worked out.

Here’s what he wrote back:

My wife and I retired in 2004 after years in the music business. We bought a house here in Nicaragua eleven years ago. By then my parents had passed away—we spent years taking care of them—and our kids were in college. So we sold our apartment in Manhattan, rented a smaller apartment there, and hit the road. We traveled all over the world for about four years, using our rental in Manhattan as a pit stop.

At one point, we were in Uruguay, in a fishing village called Punte del Diablo on the border with Brazil. We met an American there who had ridden his motorcycle from San Francisco down the west coast of South America to Patagonia and was heading back up the east coast. We asked him what his favorite place had been. He said, “Nicaragua.”

A year or two later our daughter was working on a water project in Costa Rica, so we went down. We rented a house and hung out there with our three children for Christmas and New Year’s. My wife and I felt Costa Rica was too developed. You have to remember we had lived in New York City since 1973. We’d both been in the music business. We had a house in the Hamptons. We were dealing with type A personalities. We felt surrounded and just wanted to get out.

On our travels, we found that we felt most at home in Third World countries. Costa Rica is First World. It reminded us of LA, which we hate, so we left and went north to Nicaragua. We found a house in the middle of ‘National Geographic Nowhere’ and bought it. We’re very remote. The nearest town is ——-, near the Costa Rica border. We are about fifteen miles south of it, via dirt road.  

Mark Blatte

We bought the house in 2006, traveling back and fourth to New York. Finally I told my wife, I couldn’t take the city anymore and wanted to try going down to Nicaragua full time. So we put everything in storage and came here. Surprisingly, it ain’t cheap. We figured out that it’s more expensive for us to live here than in most places in the States.  

During the last two years, we took part two huge charity projects in remote villages. My wife worked with a Canadian foundation to put in playgrounds and early this year she, I and our daughter raised money to have a well dug in a village that had had no potable water due to a drought—which we suspect was caused by climate change. The well will serve from 400 to 800 people. Good things to have done.

Then, three weeks ago, my wife took a bad fall. It scared me to death. She’s OK—nothing broke. But it shook me up. I told her I was ready to move back to the states. So we just put our house on the market. We need to be near good medical facilities. The nearest one to our home is two and a half hours.

In just 500 words, that letter may tell you more about retirement in Central America than you’d learn from hours of browsing the Internet or talking to real estate agents on the phone. It tells me that, if I decided to move to an exotic locale, I should do it during my so-called go-go years of early retirement, not the slow-go years of mid-to-late retirement. It also suggests that, even if we initially surrender to the magnetism of paradise, we’ll eventually feel the gravitational pull of home. Especially if our children, and grandchildren, are waiting for us there.  

© 2016 RIJ Publishing LLC. All rights reserved.

Ruark reports results of first FIA mortality study

Owners of fixed indexed annuity (FIA) with guaranteed lifetime withdrawal benefits have about 20% lower mortality than owners of FIAs without living benefits. That was among the findings of Ruark Consulting’s October 2016 FIA Industry Mortality Study.

The study, which included 11 million contract years of data and 165,000 deaths from thirteen participating FIA issuers, is the first mortality study of the FIA industry, according to a Ruark Consulting release.   

In other findings from the study:

  • FIA mortality experience is different. Similar to what we have seen in our variable annuity industry mortality studies since 2007, standard annuity mortality tables offer a poor fit to observed FIA experience, tending to understate mortality rates at both ends of the age spectrum. FIA mortality also varies widely across the companies participating in the study.
  • Mortality also varies by duration, tax status, and contract size. FIA mortality increases gradually by contract duration, and is significantly lower for qualified contracts with and without GLWBs. However, significantly higher mortality is evident for large contracts.
  • Caution is warranted amidst a changing regulatory landscape. The potential implementation of the “fiduciary rule” may affect the mix of qualified and non-qualified FIA business, and agent and policyholder behavior more broadly. Prudence suggests careful monitoring of experience results and more granular assumption development.

Companies participating in the study included:

  • AIG Life & Retirement
  • American Equity
  • Athene
  • EquiTrust
  • Forethought
  • Genworth
  • Midland National
  • Nationwide
  • Pacific Life
  • Phoenix
  • Protective
  • Security Benefit
  • Voya

Ruark’s FIA and VA industry studies include policyholder behavior such as surrenders, income utilization, mortality, and annuitizations, all of which help determine the long-term financial performance of those products. The study covered the period January 2007 through September 2015.

© 2016 RIJ Publishing LLC. All rights reserved.