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Decumulation Beat
A universal fiduciary standard requiring all financial advisors intermediaries to put their clients’ interest first sounds like a self-evident improvement over the status quo, but it’s hard to see how it could work.
Extending the fiduciary label assumes that all advice-giving intermediaries can act the way doctors and lawyers do. But M.D.s and attorneys usually have the independence to act in a client’s interest if they choose. Not all financial intermediaries can act independently.
A person serves the one who signs the checks. While we live in a representative democracy, most of us (i.e., those who aren’t self-employed or unionized) work in more or less benevolent dictatorships where our loyalty belongs to the firm or the supervisor who pays our wages, salaries and bonuses and controls our advancement.
As an newsroom colleague of mine used to point out long ago, people should always know “which side their head is battered on.”
A fee-only advisor who gets paid by his or her clients can take a fiduciary oath fairly easily. Conflicts of interest will arise, but the conflict takes place in the conscience of the advisor. It’s a very different scenario for advisors who are employed by big companies. If they want to advance, they have to be more loyal to the company—to sell or recommend what the company has decided its advisors will sell or recommend, for instance—than to the client.
We could debate the meaning of “advice,” “advisor,” or “best interest.” We could tell ourselves that an advisor can “switch hats” and use the fiduciary standard for one client and the suitability standard for another. We could conjecture that the parallel interests of the company, its shareholders, its employees and its clients eventually converge. But that’s only in a non-Euclidean universe, not in the everyday world.
If we created a uniform or harmonized fiduciary standard, we’d be asking some advisors to serve two masters at the same time. That’s either an impossibility or a recipe for existential stress. Or a dilution of the standard itself.
I’m not saying that only self-employed fee-only advisors are capable of acting in the client’s best interest. They’re not necessarily selfless. At a fee-only advisor conference recently, one advisor told me that she doesn’t want to see a fiduciary standard for wirehouse advisors because the fiduciary standard represents her competitive advantage over brokers.
“When I first meet clients, I explain that I’m a fiduciary, and that I work for them. And they like that,” she said. Sure, she was defending her turf from a new cohort of competitors. But she knows that when she makes a statement like that, she can make it stick. I may be wrong, but I don’t think most wirehouse advisors can do the same.
Disclosures aren’t the solution. Disclosing conflicts of interest doesn’t make them go away. The most vulnerable investors don’t read disclosures.
Ironically, Securities and Exchange Commission chairperson Mary Schapiro could determine the outcome of this debate. (The Dodd-Frank financial reform bill left the matter up to the regulators in the executive branch to define the fiduciary rules.)
Why “ironically”? According to reports in credible newspapers, Schapiro accepted a multi-million payout from the financial services industry when she left the top job at FINRA, where she was demonstrably ineffective. In her new, relatively low-paying government job, it must take a superhuman effort not to serve the financial industry first and investors second.
© 2010 RIJ Publishing LLC. All rights reserved.
The Bucket
Prudential Retirement Introduces FDIC-Insured Plan Option
In response to demand for safe investment options, Prudential has added Prudential Protection Account to its suite of institutional retirement solutions. The principal and accrued interest guaranteed investment option is insured by the FDIC for up to $250,000 per participant in Prudential’s 401(a), 401(k) and 457 employer-sponsored retirement plans.
The Prudential Protection Account is an alternative stable value vehicle that allows for FDIC insurance for individual participants in 401(a) and 401(k) defined contribution plans and governmental 457 plans.
“Prudential Protection Account offers liquidity, principal protection, and a competitive rate of return for plans that use Prudential’s recordkeeping platform,” said Carlos Mello, vice president, Prudential Retirement. The account’s funds are deposited at Prudential Bank & Trust, FSB.
Prudential Retirement offers retirement plans to public, private and non-profit organizations with about 3.7 million participants and $194.3 billion in assets, as of September 30, 2010.
Genworth Financial Repays Credit Facility Loans
Genworth Financial, Inc., announced that it has repaid $480 million of outstanding borrowings under its five-year revolving credit facilities, paying down $240 million of outstanding borrowings under each of the two facilities. With this, the company has repaid all of the outstanding borrowings under the facilities, which will remain in effect through May and August of 2012.
Former Prudential Controller Moves to New York Life
New York Life announced that John Fleurant has joined the company as senior vice president, finance, and controller, succeeding John Cullen, who spent 40 years at the company. The former controller at Prudential Financial, Fleurant reports to executive vice president and chief financial officer Michael Sproule.
Fleurant is responsible for overseeing the Controller’s, Tax, and Treasury departments, with responsibility for financial planning, accounting policy, and rating agency relationships.
In 15 years at Prudential, Fleurant was also chief financial officer for domestic businesses. He was a senior manager for Deloitte & Touche, where he spent nine years. He holds a bachelor’s degree in Accounting from Widener University and is a certified public accountant.
Letter to the Editor
Glenn Daily, a fee-only insurance consultant who publishes glenndaily.com, a website that describes itself as a “resource for making good decisions about insurance,” e-mailed RIJ last week with a response to Curtis Cloke’s letter comparing the merits of commissions and fees in the sale of income annuities. Here is Daily’s comment:
There are two problems with Curtis Cloke’s analysis of the relative merits of fees versus commissions for income
annuities (“Fees vs. Commissions in SPIA Sales,” RIJ, 11/17/10).
First, fees can be tax deductible, depending on the taxpayer’s situation. Commissions are not immediately deductible;
they become deductible as income payments are received, in the sense that the income payments are lower than they
would be without the commissions.
The tax disadvantage of commissions is even worse for qualified annuities. If tax rates remain constant, the after-tax
rate of return on qualified money is equal to the before-tax rate of return, so any expense that reduces the return is
costly. That’s why IRA plan sponsors give participants the option to pay administrative fees separately.
Second, for most consumers, separately-paid fees are more efficient than amortized commissions, because the insurer’s
cost of capital is likely to be higher than the consumer’s opportunity cost of money. Actuary Ralph Gorter explained
this product design issue very well in “Credit Card Approach to Pricing” (Product Development News, August 2000,
available at www.soa.org).
Insurers pay commissions when the annuity is issued, and then they recover those costs from the annuity. They typically
seek a return on invested capital of at least 10%, so the amortized cost will reduce the consumer’s benefits by more
than the amount of the commission—and probably by more than it would cost the consumer to finance those costs himself.
Upfront loads are better for long-term product performance, but consumers balk at upfront loads because they are
transparent and therefore painful. It is easier to sell products that bury the loading in interest rate spreads.
Average Dutch Retirement Age Stays Level
The average retirement age of Dutch workers in 2008 of 62 years did not increase compared with the previous year, Statistics Netherlands (CBS) has found. Nearly 80% of workers who retired in 2008 were younger than the official retirement age of 65.
The leveling off of the retirement age has also been attributed to weakening labor demand in the wake of the financial crisis. That is expected to change, however.
“Because pension funds can hardly pay any indexation now, people will feel the urge to keep on working longer, supported by a recovering economy and a growing demand for labor,” said Lans Bovenberg, an economist at Tilburg University and a director at Netspar, the network for retirement, pensions and aging.
Bovenberg has argued that the state pension should be raised to 68 to meet growing life expectancy. The current minority government has agreed to increase the official retirement age to 66 in 2020, but has not yet passed any legislation.
Between 2000 and 2006, employees stopped working at age 61 on average. However, in 2007, following legislation to discourage early retirement, the average retirement age increased to 62 years.
The retirement age of workers in agriculture and fisheries was the highest in 2008, at almost 65. Employees in the hotel and catering business, as well as staff at service providers in the environmental and cultural sectors, retired at age 63 on average. Workers in the care and building sectors, and in public services, took the earliest retirement (age 61).
© 2010 RIJ Publishing LLC. All rights reserved.
Health Benefit Costs Grow 3X Faster than CPI
Average total health benefit costs per employee grew 6.9% in 2010, or over $9,500—a significant acceleration from the 5.5% increase in 2009 and the biggest increase since 2004, according to the latest National Survey of Employer-Sponsored Health Plans, conducted annually by Mercer.
That was also three times faster than the growth of the Consumer Price Index in 2010 (the last year before the provisions of the Patient Protection and Affordable Care Act, known by its opponents as “Obamacare,” begin to take effect. Cost rose by 8.5% among employers with 500 or more employees, but by just 4.4% among those with 10–499 employees.
Employers expect high cost increases again in 2011. According to Mercer, employers believe that costs would rise by about 10% if they made no health program changes, with roughly two percentage points of this increase coming from changes mandated by PPACA for 2011.
However, employers expect to hold their actual cost increase to 6.4% by making changes to plan design or changing plan vendors. Mercer’s survey includes public and private organizations with 10 or more employees; 2,836 employers responded in 2010.
“Employers did a little bit of everything to hold down cost increases in 2010,” said Beth Umland, Mercer’s director of health and benefits research. “The average individual PPO deductible rose by about $100. Employers dropped HMOs, which were more costly than PPOs this year. Large employers added low-cost consumer-directed health plans and found ways to encourage more employees to enroll in them. And more employers provided employees with financial incentives to take better care of their health.”
Enrollment in high-deductible, account-based consumer-directed health plans (CDHPs) grew from 9% of all covered employees in 2009 to 11% in 2010. CDHP enrollment has risen by two percentage points each year since 2006. The cost of HSA-based CDHP coverage averaged $6,759 per employee among all employers in 2010, or almost 25% lower than the cost of PPO coverage.
Starting in 2014, PPACA sets minimum standards for “plan value” (the percentage of health care expenses paid by the plan) and “affordability” (the employee’s share of the premium relative to household income). These changes are stimulating health promotion or “wellness” campaigns.
In 2010 more employers added incentives or penalties to encourage more employees to participate: 27% of large employers with health management programs provided incentives, up from 21% last year.
As in 2009, medical plan cost increases in 2010 were about two percentage points lower, on average, among employers with extensive health management programs than among those employers offering limited or no health management programs. More than a fourth of employers with 20,000 or more employees require lower premium contributions from nonsmokers.
The prevalence of retiree medical plans slid to its lowest point ever in 2010, with just 25% of large employers offering an ongoing plan to retirees under age 65 (down from 28% in 2009) and just 19% offering a plan to Medicare-eligible employees (down from 21%). An additional 10% of employers have closed their retiree plans to new hires but continue to offer coverage to employees retiring or hired after a specific date.
The full report on the Mercer survey will be published in late March 2011.
© 2010 RIJ Publishing LLC. All rights reserved.
Balances of “Consistent” 401(k) Participants Up 32% in 2009
The average 401(k) retirement account balance rose 31.9% in 2009, according to an survey of consistent participants by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI).
After the 27.8% decline in 2008, the rise in 2009 was in line with the 2003–2007 pattern of steady increases in account balances. The full report is being published simultaneously at www.ebri.org and www.ici.org.
The EBRI/ICI survey, 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2009, is based on records on 20.7 million participants at year-end 2009, including 4.3 million who have had 401(k) accounts with the same 401(k) plan each year from year-end 2003 through year-end 2009.
Though the average 401(k) account balance fluctuated with stock market performance, balances of consistent participants grew at an average annual rate of 10.5% between 2003 and 2009, to $109,723 at year-end 2009 from $61,106 at year-end 2003.
The average account balance increased 31.9% in 2009 (compared with a 26.5% rise in the S&P 500 and a 27.2% increase in the Russell 2000 indices), which included changes in 401(k) participant account balances reflect ongoing worker contributions, employer contributions, investment gains and losses, and loan or withdrawal activity. The Barclays Capital U.S. Aggregate Bond Index rose by about 5.9 percent.
About one in five of over 20 million participants had loans outstanding at the end of 2009, up from 18% at both year-end 2008 and year-end 2007. At year-end 2009, 89% percent of 401(k) participants were in plans offering loans.
The share of 401(k) accounts invested in company stock continued its decade-long decline, falling by half a percentage point to 9.2% in 2009. Recently hired 401(k) participants generally were less likely to hold employer stock.
Stocks are still the most popular asset class. At year-end 2009, 60% of participants’ assets were invested in equity funds, the equity portion of balanced funds, and company stock, while 36% was in stable value investments and bond and money funds.
More than three-quarters of 401(k) plans offered target-date funds (TDFs) last year. At year-end 2009, nearly 10% of the assets in the EBRI/ICI 401(k) database were invested in TDFs. One in three 401(k) participants held TDFs.
Recent hires were more likely to hold balanced funds or TDFs compared with earlier time periods. At year-end 2009, about 42% of the balances of participants in their 20s was invested in balanced funds, compared with 36% in 2008 and about only 7% in 1998. At year-end 2009, 31% of the balances of recently hired participants in their 20s was in TDFs, up from almost 23%at year-end 2008.
© 2010 RIJ Publishing LLC. All rights reserved.
Low Rates Squeeze Fixed Annuity Issuers
U.S. sales of fixed annuities were an estimated $19.5 billion in third quarter 2010, according to Beacon Research’s Fixed Annuity Premium Study. Sales were essentially flat quarter-to-quarter, with only a 0.3% increase, and were down 12% relative to third quarter 2009.
Estimated year-to-date sales of $55.4 billion were 35% below YTD 2009, which was the strongest three quarter period in the eight-year history of the Beacon study. The data excluded structured settlements and employer-sponsored retirement plans.
Credited rates fell during third quarter, with top rates on multi-year guarantee annuities dropping to 3.5% from 3.9%. But the fixed annuity advantage over Treasury rates grew, and this helped MVA sales increase for the second consecutive quarter. The yield curve flattened, and fixed rate annuity sales by interest guarantee period shifted somewhat shorter as a result.
“Sales of fixed annuities were essentially flat quarter-to-quarter. This is puzzling because, although rates declined in third quarter, the spread between 5-year fixed annuity and Treasury rates widened, and that usually stimulates an overall sales increase,” said Beacon Research president and CEO Jeremy Alexander. “But the current interest rate environment poses a challenge for issuers of these annuities because it pressures profitability. Until the interest rate environment changes, these profit pressures will motivate many issuers to limit sales.”
“But MVA sales did grow 14% sequentially, so it seems that these annuities were the ones offering attractive rates. Issuers may have chosen to emphasize MVA sales because market value adjustments help to insulate them from interest rate risk. Indexed annuity sales were up 4%, partly because owners could potentially earn more interest relative to fixed rates on annuities and certificates of deposit. However, we believe indexed annuities did well mainly because of attractive lifetime income benefits, along with premium bonuses.”
Sales by category
Indexed annuity sales hit a record-high 44% of fixed annuity sales in the quarter, (42% YTD) climbing to $8.6 billion, up 4% from the second quarter and up 17% from the third quarter of 2009. They Estimated results of the other product types were:
- Book value fixed annuities, which pay a declared rate for a specific period, $6.9 billion, down 5% from the prior quarter but down 31% from the same quarter of 2009.
- Immediate and deferred income fixed annuities, $2.3 billion, down five percent from the second quarter, up 17% year over year.
- Market value-adjusted (MVA), which pay a declared rate but may adjust in value on early withdrawal, $1.8 billion, up 14% for the quarter and down 39% year over year.
On a year-to-date basis, indexed annuities also had Study-record sales and share of sales. Estimated YTD results by product type were: indexed, $23.4 billion; book value, $21.0 billion; fixed income, $6.5 billion; MVA, $4.5 billion. Income annuity sales improved 7% and indexed annuities were up 4% compared to YTD 2009. Book value sales fell 51%, and MVAs dropped 65%.
Sales leaders by company
Allianz moved up a notch to become the quarter’s sales leader, replacing New York Life, which came in third. Aviva advanced to second from third place. American Equity moved up a notch to come in fourth. Lincoln Financial Group rejoined the top five in fifth place. Results for the top five Study participants were as follows:
| Fixed Annuity Sales Leaders (in $thousands) | |
| Allianz Life | $1,970,632 |
| Aviva USA | 1,655,341 |
| New York Life | 1,442,571 |
| American Equity Investment | 1,220,590 |
| Lincoln Financial Group | 956,277 |
Sales leaders by product
Third quarter results include sales of more than 500 products, a Beacon Study record. By product type, Allianz Life remained the leading issuer of indexed annuities. New York Life replaced Western National as book value sales leader and continued as the dominant income annuity company. Great American led in MVA sales, supplanting American National. Top sellers included:
| Issuer Product | Product | Contract Type |
| Allianz Life | MasterDex X | Indexed |
| Lincoln Financial | New Directions | Indexed |
| American Equity | Retirement Gold | Indexed |
| New York Life | Lifetime Income Annuity | Income |
| Aviva USA | BalancedAllocations Annuity 12 | Indexed |
Sales leaders by channel
In the bank channel, New Directions was the new bestseller and the first indexed annuity to dominate bank sales in the Study’s history. Among independent producers, MasterDex X was again the leader. New York Life Lifetime Income Annuity was the top channel among captive agents and the New York Life Select Five Fixed Annuity led again among large/regional broker-dealers. In the wirehouses, Pacific Frontiers II (an MVA) replaced another Pacific Life product as the bestseller. Among independent broker-dealers, MassMutual’s RetireEase income annuity repeated as the favorite product.
© 2010 RIJ Publishing LLC. All rights reserved.
An Entrepreneur Tackles Decumulation, with TIPS
Six months ago, Manish Malhotra was a senior vice president at beleaguered Citigroup, tinkering with retirement income planning software. Now, as CEO of New York-based Fiducioso Advisors, he’s an entrepreneur who’s promoting his own decumulation tool.
A formal launch of his Fiducioso Investment Analytics Platform is months away. But last week Malhotra demo-ed it for the Retirement Income Industry Association.
The platform is intended to help advisors build guaranteed income streams out of annuities and a Maturity Matched Portfolio (MMP) of Treasury Inflation Protected Securities (TIPS), with withdrawals from a portfolio of stocks and bonds when needed.
“With the MMP, we can build inflation-protected income out of laddered TIPS that should be sufficient to meet the needs for a specific year,” Malhotra told RIJ in an interview this week. “If the TIPS don’t mature in a given year or if inflation expectations change, we take money from the SWP (systematic withdrawal program) account. We look at everything together, and all of the buckets are feeding money at the same point.
“We can build a plan for any degree of risk that the investor is comfortable with,” he added. “The first thing you can choose is the goal risk. You can choose a worst case for how long your money lasts. We will find a plan that gives you the maximum income within the constraints that you give us. In our next demo, to make life a little easier, we’ll have five default plans.
“Our core business will be licensing. Our client base is primarily financial advisors and wealth management firms. We won’t be going to retail retirees. The current direction is to license it on a per plan basis—that is, the license includes a financial plan based on the software—but if there is interest in an annual subscription we’re open to that.”
Taking FIAP for a spin
In short, FIAP is a “bucketing” tool. It creates income from several sources at once (like Briggs Matsko’s E.A.S.E. system) rather than assigning specific assets to specific time segments in retirement (like David Macchia’s Income for Life Model or Curtis Cloke’s THRIVE program).
Malhotra says time-segmentation didn’t appeal to him. “We could set up 30 lock boxes, one for every year of retirement. But if you wanted a 90% confidence level of success from that method, the sustainable payout rate would be only 3.48%. By pooling the money [the way we do], your payouts are improved,” he said.
The maturity-matched ladder of TIPS is the keystone of Malhotra’s approach. The ladder can stretch for five, ten or more than 20 years into retirement. Each rung can consist of zero-coupon or coupon-bearing bonds. The client liquidates a set of bonds each year, supplementing the income with semi-annual interest payments from the remaining bonds if desired.
The client’s remaining assets can be put into at-risk investments and income annuities. The allocation depends in part on what degree of portfolio failure risk—the risk of running short of money—he or she can tolerate. The tool spits out a variety of allocation options, singling out (with a green dot among competing red dots) the one that produces the highest income at the lowest tolerable risk.
A Schematic of the Financial Investments Analytic Platform
Source: Fiducioso Advisors, 2010.
The tool is product neutral, so money managers who use the software can plug in the kinds of funds, ETFs, or annuity products that they already use or like. Advisors can use ready-made tools like the PIMCO TIPS payout fund as a substitute for a custom-made TIPS ladder, Malhotra said.
A ladder of TIPS can produce more income with less risk than a conventional systematic withdrawal plan, Malhotra claimed. A 23-year TIPS ladder, he said, can safely produce a 4.6% annual drawdown from age 65 to age 95. That beats the traditional 4%. On a $2 million portfolio, that would mean an annual income of $92,000 versus $80,000.
This week, I took the demo of the FIAP for a spin. The tool let me choose my desired retirement income (from $35,000 to $80,000 from my hypothetical $1 million portfolio), tolerance for “goal risk” or portfolio failure (10% or more), the length of my TIPS bond ladder (zero years, five years or 10 years), the bond allocation of my investment portfolio (20% to 100%) and my desired allocation to a joint life fixed immediate annuity (0%, 25%, 50%, 75% or 100% of my assets).
As a baseline scenario, I chose a 0% chance of running out of money over 30 years, no TIPS ladder, a 60% stock/40% bond investment allocation, and no annuities. Given those constraints, the tool allowed me a safe withdrawal rate of $39,000 (very close to the traditional 4% rate), plus $30,000 from Social Security.
Then I tried turning a few of the dials. If I raised my acceptable risk of portfolio ruin to 10% (introducing the chance that I might run short of money after 23 years in retirement), the tool bumped my income to $74,000. If I introduced a 10-year TIPS ladder (which would absorb $430,000 of my $1 million) and put 80% of my SWP money in bonds, the tool suggested a safe income of just $67,000.
That was just the demo. There are more demos to come before the formal commercial launch next year. “In our next demo, to make life a little easier, we’ll have five default plans,” Malhotra told RIJ. The tool will also allow for tax-efficient withdrawals from taxable accounts, tax-deferred accounts, and Roth accounts, in that order. At a time when more and more advisors are thinking about retirement income, and about establishing guaranteed income floors for their clients, Malhotra expects his product to find a niche.
© 2010 RIJ Publishing LLC. All rights reserved
The Bucket
Indexed Annuities Set Sales Record
Sales of indexed annuities reached $8.7 billion in the third quarter of 2010. That was up 16% from the same period last year and up nearly 5% from the previous quarter, according to AnnuitySpecs.com’s quarterly report, based on data from 40 carriers representing virtually the entire market.
“With CDs averaging 0.56% a year and fixed annuities hovering at 3.14%, I think we can count on another record quarter to close-out the year,” said the Sheryl Moore, president of AnnuitySpecs.
Allianz Life maintained its leadership position with a 21% market share, followed by Aviva, American Equity, Lincoln National and ING, in that order. Allianz Life’s MasterDex X was the top-selling indexed annuity for the sixth consecutive quarter. The average weighted commission paid to the indexed annuity agent reached an all-time low, 6.50%.
‘Chained CPI’ Will Punish Pensioners: RetireSafe
The ‘Deficit Commission’ draft report that was released last week quickly drew criticism from RetireSafe, a 400,000-member national advocacy group for older Americans.
The draft report contained various approaches to reduce debt many directly affected seniors, two of the most onerous are; the chained Consumer Price Index (CPI) and changes to Medicare services.
“The ‘chained’ CPI will make the already flawed CPI used for the annual cost of living adjustment (COLA) even worse,” said Thair Phillips, president of RetireSafe.
The Bureau of Labor Statistics first published the chained CPI in 2002 by the Bureau of Labor Statistics. It assumes consumers adapt to higher prices by switching to cheaper substitutes for their favorite items. For example, people shop at Costco if their usual supermarket raises prices, or buy chicken if the price of beef rises.
Advocates for older Americans say that seniors don’t have the same flexibility to change their purchasing habits or have as many options as younger people. They see the use of the chained CPI as an excuse to delay cost of living increases in entitlements. A skeptic might say it’s stingier.
The chained CPI rose from 100 at the beginning of 2000 to 126.4 in September 2010, representing an increase in prices of over 26% over almost 10 years. The more common CPI-Urban rose from 168.8 in January 2000 to 218.4 in September 2010, an increase in prices of 29.4%, according to the Bureau of Labor Statistics. http://data.bls.gov/cgi-bin/surveymost?su
“Instead of adopting a fair and accurate CPI for seniors as outlined in the CPI for Seniors Act, HR 5305, the Commission goes in the opposite direction to further cut the COLA for older Americans,” Phillips said. “Reducing benefits and punishing older Americans to pay off the debt is not right or fair, and it must be stopped.”
Pershing Buys Clearing Relationships from Jefferies & Co.
Pershing LLC and the investment bank, Jefferies & Company, Inc., have reached a agreement where Pershing will assume certain of Jefferies’ clearing and custody relationships with introducing broker-dealers
Pershing, a unit of BNY Mellon, will also offer its processing services and technology solutions to Jefferies’ retail and institutional broker-dealer customers. The terms are undisclosed and are subject to regulatory approval.
Pershing to Offer Jefferson National’s Monument VA
Jefferson National, manufacturer of a flat-insurance fee variable annuity, said its Monument Advisor VA will be available to fee-based advisors on Pershing Advisor Solutions’ NetX360.
NetX360 is an open-architecture technology platform for fee-based advisors, including independent registered investment advisors (RIAs), introducing broker-dealer firms and dually registered advisors.
Under the new arrangement, fee-based advisors using NetX360 will be able to consolidate clients’ Jefferson National Monument Advisor variable annuity contract data within their clients’ brokerage accounts, allowing real-time updates of the valuation of the VA contracts on their workstation and, subsequently, on clients’ brokerage account statements.
Age – Not Finances – Drives Retirement Timing: Schwab
How do 50-something baby boomers approach fundamental questions about when it’s time to retire? According to a new Charles Schwab survey, 46% have a target date or age in mind, 38% have a target number in mind, and 34% have neither.
And what do retirees actually do? About 47% of retirees said they actually did retire when they reached their target date or age; another 27% said they retired when they reached their financial target; and 38% said they had neither a financial nor date or age target in mind leading up to retirement.
Schwab also surveyed baby boomers about their feelings on Social Security and found that, compared to the general population, 50- to 60-year-olds have far higher expectations for Social Security in retirement.
Over half (55%) of 50- to 60-year-olds are counting on Social Security to supplement their retirement income, compared to 37% for all Americans. While 46% of all Americans aren’t counting on Social Security, only 26% of 50-somethings aren’t counting on it.
Americans’ Retirement Fears Revealed
In a recent survey from Edward Jones, nearly a quarter (23%) of Americans said not being able to pay for healthcare costs in retirement was their top fear, a percentage that has actually decreased over the last four years.
In 2006, when Americans were polled on this topic, 30% said paying for healthcare was their greatest fear. The survey also found that 19% of Americans are worried about having to work longer to supplement retirement savings versus 12% in 2006.
Americans between the ages of 55 and 64 are considerably more worried (35%) about not being able to cover healthcare costs than those of lower age brackets but not as worried as those polled in 2006 (43%). Gender also influenced this sentiment, as 27% percent of women indicated that they were most concerned about healthcare costs, while only 19% of men consider this their greatest fear post retirement.
The study of 1,008 respondents, which was conducted by Opinion Research Corporation on behalf of Edward Jones, revealed that a large percentage of Americans also rank “having to work longer to supplement retirement savings” (19%) and “having to rely on others for support” (19%) as major concerns as they approach retirement. Respondents between the ages of 45 and 54 showed the most anxiety (26%) about having to work longer to supplement their retirement savings.
Americans in lower age brackets (24% of 18-24 year olds and 24% of 25-34 year olds) are most concerned about having to rely on others to support them during retirement. Additionally, within these age groups (18% in each age bracket respectively), respondents also indicated that they are more concerned about “not being able to make provisions for family” than those older than the age of 35.
Household income also had a considerable effect on respondents’ retirement fears, as Americans with annual incomes between $75,000 and $100,000, indicated that they are most concerned about “having to work longer” (35%) and “having to cut back on a desired lifestyle” (21%). Respondents in lower income brackets are more concerned about “having to rely on others for support” and “not being able to provide for family” after they are gone.
Securian Introduces Lifetime Income Benefit for MultiOption Variable Annuity
Encore Lifetime Income, a guaranteed lifetime income benefit, can now be added to many of the Minnesota Life Insurance Company’s MultiOption annuities for an additional cost. Minnesota Life is a subsidiary of Securian Financial Group, Inc.
After age 59½, annuity owners can withdraw a percentage of the benefit base, which is equal to the owner’s initial contribution (or contract value, if the rider is added at an anniversary of the initial purchase).
The rider also can be purchased as a joint benefit. Provided the benefit’s withdrawal limits are followed, the annual income is guaranteed never to fall and may rise annually without annuitization.
The Encore benefit offers three opportunities for income growth:
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Ratchets. On each contract anniversary, the benefit base is reset to the current contract value, if higher. This could also raise the amount that can be withdrawn each year. If the benefit’s withdrawal limits aren’t exceeded, the annuity owner never loses those gains to their annual withdrawal amount even if the contract value later declines. A reset could increase the cost of the benefit.
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Roll-ups. For each year (up to 10 years) the annuity owner postpones withdrawals, the benefit base rises 5%. This increases the amount of guaranteed income available in later years, but it does not add to the contract value. When applicable, the benefit base will be increased by either the reset, or the 5% enhancement, whichever is higher.
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Age brackets. The initial guaranteed annual income percentage is based on the age of the annuity owner when the benefit is added, with 4% being the lowest and 6% the highest. Depending on the owner’s age, the percentage could rise annually.
Encore must remain in place seven years and requires use of an approved asset allocation strategy. Encore Lifetime Income is an option cost in MultiOption Advisor B Class, Legend and Extra based on state approval. The cost of Encore is 1.10% (Single), or 1.30% (Joint). The benefit charge may increase upon a reset but will not exceed a maximum of 1.75% (Single), 2.00% (Joint).
ING Expands Stable Value Business
ING’s U.S. Retirement Services division reports significant growth in its stable value business in 2010, with sales of $3.6 billion through the first three quarters—a three-fold increase over the same period in 2009.
The growth has been fueled by a focus on ING’s synthetic and separate account contracts, and by leveraging the fixed income expertise of its asset management operations, ING Investment Management, the Netherlands-based company said in a release.
ING’s U.S. Retirement Services has about $277 billion in combined assets under administration and management, and serves all sizes and segments of the defined contribution market.
The company’s stable value team has added staff this year as it grows the business through plan sponsors, consultants and intermediaries. New positions have been created in product management, sales and operations.
“ING has been providing stable value solutions to plan sponsors and their employees for over three decades, building up leadership and expertise in this space,” said Rick Mason, President of Corporate Markets for ING U.S. Retirement Services. “While many wrap providers have reduced their appetite or left the business in the past two years, we’ve strategically positioned ourselves to grow in response to market demand.”
Stable value investment options, which are available exclusively to defined contribution savings plans, are designed to preserve capital and provide steady returns for participants. Stable value was one of the only asset classes to avoid losses and even deliver positive returns for participants throughout the 2008-2009 financial crisis, ING said.
With Savings, Does Quantity Trump Quality?
What matters more: How much a person saves or how they save it?
A new study from Charles Schwab, a major 401(k) plan provider, suggests that for most plan participants the answer is: How much.
Passive forms of guidance such as automatic enrollment and automatic savings escalations and the employer matching contribution have at least as large an impact on participants’ lifetime accumulations as the investment guidance they receive, according to a new survey of 1,005 of the 755,000 participants in 911 plans served by Schwab Retirement Plan Services, Inc.
After 30 years, the study asserted, a hypothetical 35-year-old participant earning $50,000 (with 2% annual wage increases) who started with a 3% deferral and gradually increased it to 8% would have $321,000 at retirement, assuming a 5% average annual growth rate. If the same person stayed at 3%, the accumulation would be only $128,000.
“Asset allocation is important, but people really need to save their way to retirement,” said Steve Anderson, head of Schwab Retirement Plan Services.
The study found:
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69% of respondents rated the employer match as the biggest driver of participation. One in four said they chose not to enroll because their employer did not offer a match. Almost three in four of sponsors of Schwab plans offer a match.
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Firms with automatic enrollment averaged 88% participation in 2009, compared to 73% participation in firms without automatic enrollment. Plans that introduced auto-enrollment in 2005 saw an average 15% increase in enrollment on average by 2009, compared to an average one percent decline in enrollment among plans not offering auto-enrollment.
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In all Schwab-serviced plans, participation averaged 76% in firms offering an employer match and 70% in firms without a match.
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83% of participants enrolled in an automatic savings program remained at the increased contribution rate a year after enrollment.
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Up to 25% of participants save at the employer match ceiling. Participants would save more if an employer matched 50% up to a 6% payroll deduction than if the employer matched 100% up to 3%.
An earlier Schwab study showed:
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70% of participants who receive 401(k) advice increase their deferral rates and those savings rates nearly double as a result, from 5% to 10% of pay.
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Participants who receive advice have a minimum of eight asset classes in their 401(k) portfolio compared to fewer than four for those choosing their own investments.
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92% of advice users stayed the course in their 401(k) portfolios from July 2008 through February 2009.
Name Game: ING DIRECT Helps Small Plan Sponsors Pick the Right Plan
ING DIRECT’s ShareBuilder 401k, a provider of retirement plans for small businesses, has revamped its product names and services to help business owners compare different 401(k) plan types and select the one appropriate for their firm.
The new product names include Individual 401k (for owner-only companies), Simplified 401k (designed to help employee-based businesses maximize contributions and automatically satisfy government tests), Customized 401k (for flexible matching and vesting options), and Tiered Profit Sharing 401k (enabling businesses to reward employees by group, tenure or age).
ShareBuilder 401k plans are comprised of exchange-traded funds (ETFs) from iShares, SPDR and PowerShares, rather than mutual funds. A registered investment advisor, ShareBuilder shares in the investment fiduciary role with its clients. The ShareBuilder Investment Committee manages the evaluation and selection of the fund line-up and model portfolios automatically for employers and their participants.
All ShareBuilder 401k products offer auto-enrollment, auto-rebalancing, Roth, signature-ready 5500s and much more. Each plan provies access to 401(k) consultants, customer success managers, implementation specialists and customer care for each participant.
© 2010 RIJ Publishing LLC. All rights reserved.
Quote of the Week
American Funds Is the Top Brand in Large Cap Funds
American Funds is considered the “go-to” provider of large-cap growth and large-cap value funds among registered investment advisors, according to a new report from Cogent Research.
Virtually all advisors who use mutual funds include large-cap growth or value funds in their lineup; 39% use large-cap American Funds product for the growth portion and 31% for the value.
BlackRock, American Funds’ nearest competitor in these two asset classes, is named as the “go-to” fund provider by 7% and 6% of advisors, respectively.
No single fund company dominates among advisors seeking mid-cap, small-cap, or international product offerings, according to Cogent’s Advisor Trends in Asset Class Mix 2010TM, a report based on a nationally representative survey of over 1,400 registered advisors.
American Funds dominate all channels except for the registered investment advisor (RIA) channel, where Vanguard Group, Fidelity Investments, and, to a lesser extent, DFA (Dimensional Fund Advisors) pose a challenge.
In all six style boxes comprised of mid-cap and small-cap asset classes, Fidelity Investments and Franklin Templeton are just a few points behind American Funds for advisors who name them as “go-to” providers in these categories.
Franklin Templeton is strong among Regional and Bank channel advisors. “There’s a lot more competition… outside of the large-cap arena,” said Tony Ferreira, Managing Director of Cogent’s Wealth Management practice. “At least a half dozen fund companies are in the hunt within the mid- and small-cap fund space.”
“Take The Hartford and Lord Abbett, for example,” he added. “Among Regional [broker-dealers], these two players match or surpass what a number of larger competitors, including American Funds, are doing in all three mid-cap categories.”
For international equity funds, American Funds and Franklin Templeton were named by 25% and 17% of advisors respectively as their “go-to” provider. Beyond those two providers there are at least 30 contenders each with their own small piece of the pie.
© 2010 RIJ Publishing LLC. All rights reserved.
UK’s National DC Plan Considers Investment Options
The National Employment Savings Trust (NEST), the U.K.’s state-sponsored defined contribution plan, has ruled out any direct investments in infrastructure, commodities and high yield assets in its first few years of existence, IPE.com reported.
“We won’t be investing in a single infrastructure fund, though, or a single commodities fund, or a single high-yield fund until we get bigger,” said Mark Fawcett, CEO of the program. The fund could get some exposure to those asset classes through its diversified beta fund, however.
The fund isn’t required to invest in UK equities, Fawcett said, but its overall global equity mandate will allow for 10% to be invested in local equities.
While it is still undecided whether NEST will link its pensions to the consumer price index (CPI) or the retail price index, Fawcett acknowledged the government had recently deemed CPI the appropriate measure for pensioners.
Fawcett hoped that, in time, the program would clear internally, lowering the cost and minimizing selling and buying, as the constant influx of new members would create ongoing demand for funds sold by members who are retiring.
He said that with the help of target-dated funds, NEST would be able to minimise confusion and allow people to simply set a retirement date, allowing the default investment strategy to then adjust as the pension age approached.
However, the notion of high risk and return, as well as low risk and return, socially responsible investment funds and religiously compliant funds are still being considered, and final details will be announced in the new year when trustees unveil the scheme’s Statement of Investment Principles.
As for the ultimate size of the scheme after launch, Fawcett said it was impossible to predict, as the soft launch will still require the employees of select companies to opt into the scheme.
Fawcett said that “hedge funds might have a place, certainly, at some point” in the program, but their huge performance fees conflict with the program’s low-fee philosophy. “A lot of pension funds are going into hedge funds at the moment, but it’s perhaps not the first place we’re likely to go,” he added.
© 2010 RIJ Publishing LLC. All rights reserved.
75-Year Financing Plan Would Stabilize Social Security: NASI
A research brief released by the National Academy of Social Insurance (NASI) describes what it calls a program of affordable Social Security reforms that most or many Americans would support.
The new policy paper, Strengthening Social Security for the Long Run, by NASI president Janice M. Gregory, Thomas N. Bethell, Virginia P. Reno, and Benjamin W. Veghte.
While Congress addressed the immediate funding crisis the program faced in 1983, it did nothing to resolve the program’s long-term deficit except to call for phasing in an increase in the retirement age from 65 to 67. That benefit reduction is still being phased in today, the report explains. Congress did not add any new revenue, even though providing future revenue had been an accepted practice in the past.
The Social Security program today does not face the same kind of crisis it did in 1983, when a short-term financing problem occurred. Nor is its cost ballooning out of control: Even though the percent of the population receiving Social Security benefits will increase from about 17% today to 25% in 75 years, the cost of the program as a percent of the economy will increase only from about 5% to about 6%.
But NASI sees three reasons to doubt the future adequacy of Social Security benefits. First, average benefits are only about $14,000 today; second, benefits are projected to decline as a percent of prior earnings; third, other sources of retirement income are becoming less secure and less adequate.
Covering the projected long-term shortfall facing Social Security would require revenue increases equal to slightly more than 2% of taxable payroll over the next 75 years, according to the authors. That revenue could be raised by lifting the FICA contributions cap to again cover 90% of earnings “as Congress intended and scheduling potential FICA rate increases for points in the distant future when additional funds would strengthen the program,” NASI said in a release.
© 2010 RIJ Publishing LLC. All rights reserved.
An Alternative Deficit Reduction Plan
Former Federal Reserve vice chair Alice Rivlin, a member of President Obama’s deficit-reduction commission and co-chair of a separate 19-member group sponsored by the Bipartisan Policy Center in Washington, today proposed a 6.5 percent national sales tax to reduce the U.S. budget deficit.
Rivlin’s recommendations come as week after the commission’s co-chairmen, Erskine Bowles and Alan Simpson released a draft proposal and two weeks before the commission’s recommendations are to be delivered to Congress.
As reported by Bloomberg News, Rivlin, a Democrat, and former New Mexico Republican Senator Pete Domenici, are offering a more aggressive approach to tax increases and cuts to Medicare than the Bowles-Simpson plan did.
Similar to the Bowles-Simpson proposals, the Rivlin plan would lower income tax rates while eliminating most deductions and credits. It would replace the home mortgage and charitable contribution deductions with 15% refundable credits.
The plan also makes $756 billion in cuts to health care costs through 2020, including raising Medicare premiums from 25% to 35% over five years, and starts a premium support program to limit growth in federal spending on the health-care program for the elderly. It also attempts to spark economic growth with a one-year Social Security payroll tax holiday designed to create 2.5 million jobs.
“It is a fundamental difference” with the Bowles-Simpson plan, said Steve Bell, a scholar at the Bipartisan Policy Center. “They assume that this deficit reduction plan in and of itself is sufficient. We don’t.”
On Social Security, instead of raising the retirement age, as in the Bowles-Simpson plan, the Rivlin group proposes a gradual increase in the amount of wages subject to payroll taxes, currently $106,800, over the next 38 years to cover 90% of all wages. It would also trim the annual cost-of- living adjustments and reduce the growth in benefits for the top 25% of beneficiaries.
The Rivlin-Domenici plan seeks to illustrate why a combination of spending cuts and tax increases is the only way to stabilize the debt by 2020. According to their report, targeting domestic discretionary spending cuts alone would require eliminating almost everything from law enforcement and border security to education and food and drug inspection.
The nation also cannot grow fast enough to grow its way out of the deficit, the report says. To stabilize the debt at 60% of GDP, the economy would have to grow at a sustained rate of more than 6% a year for at least the next 10 years—more than 1.5 points faster than in any decade since World War II.
Finally, raising taxes on wealthy Americans won’t by itself solve the problem, the report says. Reducing deficits to manageable levels by the end of the decade would require raising rates on the top two income brackets to 86% and 91%, the report says.
© 2010 RIJ Publishing LLC. All rights reserved.
Millionaires Haven’t Abandoned the Equities Market
A new survey of millionaire investors commissioned by U.S. Bank and conducted online by Harris Interactive offers a fresh look at how this group managed their assets through the recession and how they are investing today.
“The vast majority of millionaire investors have persevered and remained in the market,” said Mark Jordahl, president of U.S. Bank Wealth Management Group. “They haven’t overreacted. They’ve maintained a balanced approach to risk and its potential rewards, and they are confident about achieving their long-term investment goals over the next six to ten years.”
The Private Client Reserve of U.S. Bank Millionaire Investor Insights Annual Survey, which looks at investment attitudes, behaviors, risk profile and strategies of millionaire investors, was conducted between September 27 and October 15 among 1,609 U.S. households with investable assets of $1 million or more.
Some of the findings challenge conventional assumptions about investor behavior since the economic and market downturn began. The highlights:
- 92% of millionaires have not abandoned the stock market, with 43% currently engaged in moderate to heavy buying or selling and 49% waiting for the right opportunity to buy or sell.
- 20% of millionaires who lost value in their investments since 2008 have already seen their investments return to pre-2008 levels, and 90% indicated that their investments performed better or about the same as other investors since the beginning of 2008.
- 47% say their investment risk tolerance has not changed during the last three years and only one in 10 say they are not willing to take any investment losses in the current investment market.
- In the past three years, 47% percent of millionaires made no change in their allocation to equities, 42% made no change in their allocation to fixed income, and 47% made no change in their allocation to cash.
- 72% said the U.S. stock market performance has a major or moderate impact on their investment strategies.
- Many (43%) are currently engaged in moderate to heavy buying or selling to take advantage of market opportunities, and 49% are looking for the right opportunity to buy or sell.
- 20% percent have already seen the value of their investments return to pre-2008 levels, and 54% feel it will take up to five years for their investments to get to where they were prior to 2008.
- 90%say their investments performed better or about the same as other investors.
- Many millionaires (45%t) say they have become more conservative with regard to their investment risk tolerance during the past three years, but 47% say their investment risk tolerance has not changed.
- A vast majority (93%) says worries about their investment performance have not caused them to lose sleep at night.
- Only 10% of millionaires said their primary motivation for investing is to protect their wealth by limiting losses.
- A majority (61%) are investing to maintain their wealth by seeking a rate of return that outpaces inflation, fees and taxes or to increase their wealth by seeking portfolio growth (29%).
- 80% are personally involved in making decisions about their investment portfolios, with 20% delegating most or all of their investment decisions to their financial advisor.
- A majority of millionaires (70%) trust their financial advisor to help them grow their investments and 71% say they get advice from others about how to invest, but go with their own instincts.
The Private Client Reserve of U.S. Bank inaugural Millionaire Investor Insights Annual Survey monitors the investment attitudes, behaviors, risk profile and strategies of millionaire investors in the United States. The national survey was conducted online for U.S. Bank by Harris Interactive between September 27 and October 15, 2010 among 1,609 respondents over age 18 with $1 million or more in household investable assets (excluding primary and secondary residence and assets held in employer-sponsored retirement plans).
© 2010 RIJ Publishing LLC. All rights reserved.
Fees vs. Commissions in SPIA Sales
After reading RIJ’s article last week on the proceedings of the recent NAPFA conference in Boston (“Singing from the Fee-Only Song Book,” RIJ, November 11), financial planner Curtis Cloke of Burlington, Iowa, sent these comments:
There are many myths and misunderstandings about income annuities. The reality is not always obvious. Take the issue of advisor compensation, for instance. When a client incorporates an immediate annuity into a custom financial plan, we shouldn’t ask what revenue method is best for the advisor; we should ask what method is best for the client.
When the issuer pays the advisor a 3% commission, the commission comes from the spread that’s priced into the contract and the issuer recoups it over the life of the contract. A fee-only advisor, on the other hand, charges a fee in addition to the cost of the annuity and the client pays him or her with purely after-tax dollars.
Let’s assume, for example, that you have a non-qualified deferred annuity contract that has been in effect for a period of time and has grown from an initial $75,000 to a current value of $100,000. Let’s further assume that the client wants to 1035-exchange the contract to an immediate or deferred income annuity.
If the manufacturer pays the advisor—perhaps an insurance agent—a 3% commission, the manufacturer would amortize $3000 over the life of the contract, and deduct it internally with no tax implications for the client at the time of purchase.
But a fee-only advisor, recommending the same product, would discount the cost of the annuity by $3,000 and charge a one percent fee over three years. In that case, the client will have to pay that fee with after-tax earnings. Counting the tax, the client might end up effectively paying more like $3,550 than $3,000. Is that better for the client?
If the income annuity was purchased with qualified money from an IRA or a 401(k), the manufacturer who pays an upfront commission is re-paid from the client’s pre-tax assets. The transaction creates zero tax impact to the client. The client who pays a fee-only advisor doesn’t get the same benefit.
In addition to manufacturers that will price a “net of commission” single premium income annuity (SPIA), there are also platforms that offer institutionally priced SPIAs. The platform typically charges a 2% to 2.5% fee, on top of which the fee-only advisor charges one percent. The platform fee and the fee charged for the advice must now be paid for with after-tax income. In this scenario, the client may pay significantly more for the annuity than when a commission is internally financed by the manufacturer.
If you do the calculations, you’ll find that charging a fee instead of a commission may in fact be less beneficial for the client. In any case, it’s certainly no better for the client to pay three percent in fees than to pay a three percent commission.
Your story also touched on the cost of an inflation rider on an income annuity. Today you can purchase an inflation rider that increases the payout by a fixed annual percentage or by the change in the Consumer Price Index. I advise my clients to elect the fixed percentage and not the CPI-driven rider.
As the RIJ article accurately explains, when the insurance company prices an open-ended benefit like a CPI-driven adjustment, it will always use worst-case assumptions. If you elect a KNOWN percent inflation feature, there is no guesswork or risk to the manufacturer. A fixed inflation adjustment purchased as a rider on a period-certain income annuity will actually provide higher internal rates of return than an income annuity with no inflation rider. In our clients’ retirement plans, we often build ladders of SPIAs and deferred income annuities with fixed-percentage inflation adjustments.
Curtis Cloke is the creator the THRIVE Income Distribution System.
How to Expect the Unexpected (in a Retirement Income Plan)
The traditional “4% rule” regarding sustainable lifelong withdrawals from retirement savings works only if you neglect to anticipate the cost of emergencies, says a noted financial consultant.
If you incorporated the risk of emergencies, the sustainable withdrawal rate would sink to 3%, writes Gordon B. Pye, Ph.D., in the current issue of the Journal of Financial Planning. To put it another way, you’d have to arrive at retirement with 33% more savings than you thought you needed.
Emergencies can be worse than bear markets because they don’t correct themselves, Pye says; they don’t obey the principle of reversion-to-the-mean. Like bear markets, however, they pose timing risks. Their effect is worse if they occur near the beginning of retirement instead of near the end.
The retirement planning software that exists today is flawed to the extent that it doesn’t help advisors incorporate the risk of emergencies into their spend-down rates, either before or after an expensive emergency, he says.
There’s a one in 20 chance of an emergency occurring every year during retirement and, on average, one expensive emergency will occur during a 20-year retirement, Pye says. He projects a 38% chance of one emergency during retirement, a 36% chance of no emergencies, a 19% chance of two, a 6% chance of three and a one percent chance of more than three.
In the past, Pye has written about the Retrenchment Rule, a discounting technique that adjusts withdrawal rates downward during retirement. This rule accommodates the tendency for retirees to spend more money early in retirement (during the Go-go years) than later (during the Slow-go and No-go years). He uses an annual Retrenchment Discount Rate of 8% to deflate future projected withdrawals during retirement.
“A more active and expensive standard of living gradually becomes less desirable as lifestyles necessarily slow with age even for those who remain in relatively good health,” he mordantly observes.
If a large unexpected emergency expense takes a chunk out of savings, he recommends sticking to the prescribed withdrawal rate, even if doing so entails a reduction in standard of living. To protect against insufficient income later in life, Pye has in the past recommended either buying a life annuity or allocating a “sizable portion of the portfolio each year to fixed-income issues.”
© 2010 RIJ Publishing LLC. All rights reserved.
The $1.1 Trillion Tax Hike
The most provocative idea in the PowerPoint slides released last week by the co-chairs of the National Commission on Fiscal Responsibility and Reform was “Option 1: The Zero Plan.” It was buried so deeply in the document, however, and was couched in such bureaucratic language, that not everyone noticed it.
Option 1, on page 23, says that the government should “eliminate all $1.1 trillion of tax expenditures” and apply the new revenue to reduce the deficit and tax rates. It would add back any particularly desirable tax expenditures and increase the tax rate to pay for them.
This modest proposal—assuming that it’s more than a bluff or a bargaining chip—obviously isn’t so modest.
First, it suggests that Americans already give themselves a generous $1.1 trillion in tax breaks every year. Second, it implies that every exemption, deduction, exclusion, credit and deferral in the IRS code—from the mortgage interest deduction to corn syrup price supports—is a form of government spending.
Third, and most importantly for anyone in the retirement income industry, it knocks the legs out from under the employer-sponsored retirement savings industry and the insurance industry, which are predicated on tax deferral and exemptions.
Some observers recognized right away what the Zero Option meant. One of the first to attack it last week was Brian Graff, CEO of the American Society of Pension Professionals and Actuaries (ASPPA), which represents thousands of third-party retirement plan administrators and others.
“The proposed ‘Zero Option Plan’ would decimate the savings rate by eliminating tax incentives for contributing to employer-sponsored retirement plans, such as 401(k) plans, likely triggering mass terminations of company retirement plans—directly impacting a worker’s ability to save for retirement,” Graff said in a press release.
“The 401(k) acts as the primary savings vehicle for most Americans and eliminating these tax incentives would strip them of critically important benefits and protections provided by the Employee Retirement Income Security Act of 1975 (ERISA). Simply put, the retirement security of American workers will greatly suffer if the Deficit Reduction Commission’s recommendations are enacted.”
Another first-responder was blogger Michael Cannon at the Cato Institute website. For Cannon, the use of scornful expressions like “tax expenditure” and “backdoor spending in the tax code” in the Proposal when referring to tax breaks was a sure sign that someone’s hand was about to reach into his pocket.
“To call them ‘tax expenditures’ or ‘tax subsidies’ or ‘backdoor spending in the tax code’ is to claim that when the government fails to take a dollar from you, it is spending that dollar,” Cannon fumed. “It implies that your dollar actually belongs to the government, which is graciously letting you keep it. And it implies that eliminating a tax loophole is not a tax increase, because that dollar already belonged to the government anyway. The government has simply decided to spend its money somewhere else. When you hear a politician use the terms tax expenditure, tax subsidy, or backdoor spending in the tax code, beware. He’s about to raise your taxes.”
The Zero Option was so audacious that some people gave it little chance of being taken seriously. (After reading the Deficit Commission’s PowerPoint last week, I e-mailed a prominent figure in the 401(k) industry. “I think it’s a trial balloon or a negotiation ploy, rather than a serious threat,” I wrote. “They’re just saying ‘Everything is on the table.’” “Agreed,” he wrote back.)
Others felt the same way. In an e-mail to a LinkedIn discussion group, Boston-based consultant Leslie Prescott wrote, “The implications would be enormous. Aside from any company matches, there would be little incentive for employees to participate. Their proposal is completely at odds with the efforts of other areas of the government to increase retirement savings, and the industry’s lobbyists will be furiously trying to squash it. I believe this measure has 0% chance of being implemented.”
That may be why more people focused on the Social Security section of the draft proposal. It suggested a wide range of partial fixes for the old age insurance program, including raising the retirement age, adopting a more conservative COLA index, and gradually increasing the wage base for payroll taxes to about $175,000 from $106,000 over the next 40 years.
Steven Sass of the Center for Retirement Research at Boston College, who has written a history of the private pension system in the U.S. and recently helped produce a Social Security Claiming Guide, was generally positive about the Bowles-Simpson recommendations.
“Raising the retirement age is sensible. The change in the CPI makes sense. It makes Social Security work the way it ought to work, with two caveats. The chained CPI is based on notion that people change their shopping habits when prices go up. But older people don’t necessarily change habits as easily as younger people, so chain linking isn’t a good measure for them,” Sass said.
“The basic issue for social security—it’s largely a matter of what the young want,” he continued. “People approaching retirement won’t be affected by the increase in the retirement age, so a lot of reform is based on [changing Social Security for] young people. Ultimately, they will have to decide whether they want to pay less tax or get more benefits. It would be great to hear from them. The current proposal is weighted more toward benefit cuts than tax increases, and I don’t know if that would be their choice. It’s hard for them to appreciate the difference. I’d love to have someone set up a national vote on it.
“For Social Security, the shift in the dependency ratio is the underlying problem. If we move the retirement age out five years, we can get back to a three-to-one ratio of workers to retirees. But the more you raise the retirement age, the more people you get on disability. That’s a mess,” Sass said.
“My real fear is that we’ll quickly slip into a means-tested system. Pretty soon you have half the population on means testing. Means-testing makes people hide their means or it discourages work. There’s pain coming, and we’ve got to take our medicine. We’ve known for over 20 years that Social Security had a long-term financing problem, but liberals don’t want to cut benefits and conservatives want individual accounts and we haven’t been able to deal with that.
“But the solution is not look for scapegoats or nostrums. We have to find a better way than, ‘We don’t want to take our medicine.’ People tend to overestimate the utility of money and underestimate the utility of not being surprised by financial problems or not having to worry about money.”
© 2010 RIJ Publishing LLC. All rights reserved.
Draft of Deficit Reduction Proposals Released
On Wednesday, the chairmen of the Obama administration’s bi-partisan National Commission on Fiscal Responsibility and Reform released a PowerPoint draft of their recommendations for reducing the annual federal budget deficit, now over $1 trillion as a result of spending to mitigate the effects of the financial crisis.
The draft proposes a wide range of cuts throughout the federal budget, but makes a point of strengthening Social Security without privatizing it and suggests simplifying the IRS code to three tax brackets with a maximum marginal income tax rate of 35% and a corporate tax rate of 26%.
But the commission’s modest proposal to question all $1.1 trillion worth of annual “tax expenditures,” including tax deferral in retirement plans, has some worried.
“We are deeply concerned that recommendations from the draft report issued today from the chairs of the Deficit Reduction Commission would eliminate tax incentives for retirement savings and negatively impact the ability of working Americans to effectively prepare for retirement,” wrote Brian Graff, CEO of the American Society of Pension Professionals and Actuaries, in a release.
“As drafted, one of the options listed in the proposal would eliminate the tax incentive for employers to offer retirement plans to their employees—which ultimately hits low and moderate income workers the hardest. Data prepared by the Employee Benefit Research Institute (EBRI) suggests that only 5% of workers save for retirement on their own, without the benefit of an employer sponsored plan. By contrast, 70% of moderate to low income workers earning between $30,000 and $50,000 participate in employer sponsored retirement plans when they are offered,” the release continued.
“The proposed “Zero Option Plan” would decimate the savings rate by eliminating tax incentives for contributing to employer-sponsored retirement plans, such as 401(k) plans, likely triggering mass terminations of company retirement plans—directly impacting a worker’s ability to save for retirement,” Graff said.
The plan reduces the budget deficit to “sustainable levels” by 2015 but doesn’t predict a balanced federal budget until 2037—when the youngest boomers will have just begun taking required minimum distributions.
Social Security reform is covered on pages 42 through 50 of the draft proposal. The recommendations include preventing the 22% across-the-board benefit cuts anticipated in 2037, making the benefit formula more progressive so that high-income recipients receive relatively less, taxing 90% of covered earnings by 2050, indexing the retirement age to longevity gains, dampening COLAs and many other specific optional measures.
The draft proposal also includes recommendations to:
- Cut defense spending by $100 billion in 2015, with savings to come from overhead reduction, overseas base closings, and reductions in defense contracting.
- Freeze federal non-defense pay for three years.
- Reduce the federal workforce by 10% and eliminate 250,000 non-defense contracting jobs.
- Eliminate all $1.1 trillion in “tax expenditures,” i.e. subsidies, and reinstate them on a case-by-case basis.
- Limit mortgage deduction to primary residences, cap at $500,000 mortgages and eliminate tax deduction for home equity loans.
- Cap the federal share of Medicaid payments for long-term care.
© 2010 RIJ Publishing LLC. All rights reserved.
