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Interpreting SEC’s new ‘principles-based’ advertising rule: Wagner Law Group

Posted on February 27, 2020 by -

In early November 2019, the Securities and Exchange Commission (SEC) released proposed amendments to the advertising rule and solicitation rule under the Investment Advisers Act of 1940 (“Advisers Act”), Rules 206(4)-1 and 206(4)-3, respectively.

The proposed amendments attempt to modernize the rules to reflect technological changes, today’s investor expectations, and current industry practices. Over the years, both rules have been interpreted and supplemented via no-action letters and other guidance.

The relevant letters and guidance are listed in the SEC’s release and they will be reviewed to determine whether any should be withdrawn in connection with the adoption of the proposed amendments, which shift the rules’ existing “specified limitations” approach to a more flexible so-called “principles-based” approach.

Given the broad scope of the proposal, and the potential for a significant increased effort by chief compliance officers to comply with the changes, we will address a few elements of the advertising rule proposal below, and discuss the solicitation rule in a subsequent Investment Management Law Alert.

Amendment to Advertising Rule

The advertising rule should be understood against the backdrop of the anti-fraud rule. Section 206 of the Advisers Act makes it unlawful for any investment adviser, whether registered or unregistered, to directly or indirectly engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative. Advisers have an affirmative obligation of utmost good faith and full and fair disclosure of all material facts to their clients, as well as a duty to avoid misleading them. A financial adviser’s “intent to deceive” is not relevant per se and is not required by the language of the Advisers Act.

The rule is broad and applies to all firms and persons meeting the Advisers Act’s definition of investment adviser, whether registered with the SEC, a state securities authority, or not at all. It also applies to all written correspondence, not just to advertisements. Section 206(4) of the Advisers Act grants the SEC authority to define acts that are fraudulent and to prescribe means reasonably designed to prevent fraud.

Definition of advertisement. First, the proposed amendment would change and broaden the definition of “advertisement.” The SEC views the current definition in Rule 206(4)-1(b) as inflexible and proposes a new definition that is intended to be more “evergreen” in light of ever-changing technology.

The proposed amendment would redefine “advertisement” to include any communication disseminated by any means, by or on behalf of an investment adviser that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.

The proposed “dissemination by any means” language would change the scope of the rule to cover all promotional communications, which would better focus the rule on the goal of the communication, rather than on its method of delivery. The proposed “by or on behalf of the investment adviser” language would cover advertisements disseminated by an adviser’s intermediary.

The amendment proposes to exclude the following from the definition of “advertisement”:

(1) Live oral communications that are not broadcast;

(2) Responses to certain unsolicited requests for specified information;

(3) Advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other SEC rules; and

(4) Information required to be contained in a statutory or regulatory notice.

Observations:

  • Excluded communications may not relate to performance or hypothetical performance information.
  • Must consider communications authorized by adviser to be made by third-party intermediaries, as well as affiliates.
  • Specifically applies to investors in pooled investment funds.
  • Replaces “written” communications with “any communication, disseminated by any means.”

Testimonials, endorsement and third-party ratings permitted. The advertising rule has four specific prohibitions (hence, the “specified limitations” approach) and one “catch-all” provision.

Advertisements that refer, directly or indirectly, to any testimonial concerning the adviser or any advice, analysis, report, or other service rendered by the adviser, is one of the four prohibitions.

The proposed amendment would permit the use of testimonials, endorsements, and third-party rankings in advertisements, subject to specific disclosures including whether the person providing the endorsement is a client, whether compensation was paid for the endorsement, and certain criteria pertaining to the preparation of the rating.

Observations:

  • The SEC is addressing the ability of technology platforms that allow instantaneous sharing of testimonials and endorsements.
  • Must disclose both cash and non-cash compensation provided by or on behalf of the adviser, but does not define any definition to the term “non-cash compensation” nor does it have a threshold amount.
  • SEC is attempting to protect the integrity of third-party ratings by requiring that the adviser reasonably believe that any questionnaire or survey used in preparing such third-party rating is structured so that it is equally easy for a participant to provide both favorable and unfavorable responses.

Performance reporting and retail investors. The Advisers Act and underlying rules do not contain any direct prohibition concerning the use of performance data in advertising, nor does it articulate a prescribed method by which past performance must be calculated. Rather the calculus turns on whether the advertising of performance is false or misleading, based on a “facts and circumstances” approach.

Under this approach, the use of performance results is false or misleading if it implies, or a reader would infer from it, something about the adviser’s competence or about future investment results that would not be true had the advertisement included all material facts. The proposed amendment would permit the use of performance advertising with some specific prohibitions. The investment advisor must meet more rigorous requirements when the intended audience is a retail investor.

Observations:

The proposal makes a distinction between retail and non-retail advertising. In simple terms, a non-retail advertisement is distributed to a “qualified purchaser,” or a “knowledgeable employee,” and a retail advertisement is all other advertisements that are not “non-retail.”

The proposal identifies numerous classes of performance data: net, gross, related, extracted, and hypothetical. Ported performance is not directly covered in the proposal.

The proposal addresses other areas of advertisements:

It would require a rigorous pre-review and compliance approval by a designated person, who the SEC indicates should be competent and knowledgeable, and should reside in the compliance or legal department. Comments are invited as to whether an outside party could perform the requisite review.

Certain communications to a single person or private fund investor, and live oral communications that are broadcast over TV or the Internet would be exempt from pre-review.

The proposal would also amend the books and records requirements under Rule 204-2 to create and maintain specified communications, third-party questionnaires and surveys, and records that evidence the pre-review process.

© 2020 Wagner Law Group.

Lifetime income withdrawals from FIAs up 39%: Ruark

Posted on February 27, 2020 by -

Ruark Consulting, LLC has released the results of its 2020 industry studies of fixed indexed annuity (FIA) policyholder behavior, which include surrenders, income utilization and partial withdrawals. Ruark’s FIA studies cover products both with and without a guaranteed lifetime income benefit (GLIB).

“With new data contributors, and rapid growth in the FIA market, data exposures in key areas continue to increase,” said Timothy Paris, Ruark’s CEO. “More data enables us to do more detailed analysis, identify new patterns, and—critically—help our clients achieve meaningful risk reduction in their models.”

Among the notable increases in exposure:

  • Total exposure years grew to 23 million, a 21% increase over the 2019 study
  • Double the exposure years for GLIB contracts past the end of the surrender charge period
  • A 39% increase in lifetime income withdrawals, to $5.4 billion
  • The study data comprised over 4 million policyholders from 17 participating companies spanning the 12-year period from 2007-2019, with $296 billion in account value as of the end of the period. GLIB exposure constituted 44% of exposure overall, and 49% of exposure in the last 12 study months.

Highlights include:

Lifetime income commencement rates are low: 6% overall in the first year following the end of the waiting period and then falling to less than half that subsequently. But there is evidence of a spike in commencement after year 10, particularly where the benefit is structured as an optional rider rather an embedded product feature. Age, tax status, and contract size all influence commencement rates.

Lifetime income commencement increases sharply when policies are in the money, that is, when the benefit base exceeds the account value. After normalizing for age, tax status, and contract duration, commencement rates are about five times higher for contracts that are 25% in the money or more.

Surrender rates continued to climb in 2019, particularly among contracts past the surrender charge period. The increase is broadly consistent with the rise in FIA sales that has been reported across the industry. This trend is also evident for contracts with a GLIB, where surrenders rates are much lower, particularly after lifetime income commencement.

While surrender rates for contracts with a GLIB appear insensitive to nominal moneyness (the relationship of account value to the benefit base), an actuarial moneyness basis which discounts guaranteed income for interest and mortality rates indicates surrender rates are lower when the economic value is higher, as should be expected.

The relationship between higher surrender charges and lower surrender rates can be quantified. The study examined the relationship of surrender rates to the effective surrender charge, that is, the difference between account value and cash surrender value, which includes the potential effects of market value adjustment (MVA) and bonus recapture.

Surrender rates are sensitive to credited rates and external market pressures. Contracts earning less than 2% exhibit sharply higher surrenders than those earning more. As market interest rates increase, so do surrenders, though there is some indication that a higher credited rate tempers the increase. In contrast, equity market returns are negatively correlated with surrenders.

Detailed study results, including company-level analytics, benchmarking, and customized behavioral assumption models calibrated to the study data, are available for purchase by participating companies.

Ruark Consulting, LLC (www.ruark.co), based in Simsbury, CT, is an actuarial consulting firm. It provides a platform and industry benchmark for principles-based insurance data analytics and risk management. Ruark has an ongoing collaboration with the Goldenson Center for Actuarial Research at the University of Connecticut.

© 2020 RIJ Publishing LLC. All rights reserved.

Why Bernie is So Demanding

Posted on February 27, 2020 by -

If Bernie Sanders, the left-of-center senator from Vermont, becomes the Blue candidate for president, expect political dirt like you’ve never seen. But underneath the mud and memes, behind the deepfakes and denials, we may witness a legitimate debate over the relative merits (and demerits) of supply-side and demand-side economics.

Supply-side economists believe that if you lower taxes and cut regulations, entrepreneurs will be unleashed to create new businesses, hire more workers, produce more stuff, and even generate more tax revenue for government.

Supply-siders have been in the macroeconomic saddle for the past 40 years. The word “saddle” is apt: the concept roared out of the American West. Arthur Laffer (who advised Donald Trump in 2016) was its premier economist. Journalist Jude Wanniski popularized the term “supply-side” and published a 1978 book about it. Ronald Reagan implemented it, more or less. After the “stag-flation” of the 1970s, supply-side economics blew in like a refreshing zephyr.

And many people became gloriously rich as a result. The early 1980s saw the start of the longest bull market, in both stocks and bonds, that the universe had ever seen. Though factories went dark, the deregulated financial and tech sectors flourished. The fact that tens of millions of baby-boomers were working, saving, buying homes and procreating didn’t hurt.

Wage deflation

But today, there are signs that the supply-side miracle has run its course. Boomers are retiring. Interest rates have no room left to fall. Tax cuts have added to unprecedented deficits. Homes and financial assets are priced to the max. The financial crisis showed that deregulation has a downside.

Supply-side economics brought, or coincided with, rising inequality. America gradually divided into two camps: A minority with large amounts of appreciated assets, like homes and securities, and a majority with few or no assets that appreciate. The ever-widening gap between haves and have-nots is well-documented.

As the Pew Research Center reported this month, national income is concentrated among fewer people. Eighty percent of Americans now receive only 43% of national income, down from 56% in 1968. Instead of inflation (the bane of creditors), we’ve seen wage deflation (the bane of debtors). Consumer prices have almost doubled since 1990, but wages have grown only 26.5%. We’re at full employment, but the civilian labor force participation rate is lower than it was in 2000.

This creeping poverty, linked to globalization, shows up in the falling life expectancies of rural white workers with less than college educations. Unable to earn adequate pay, many don’t marry, form families or set up households. Frustrated by their failure to meet their own and society’s expectations, they become prey to OxyContin, heroin and anger. Once proudly self-reliant, they welcome someone to blame.

The president rode to victory on that wave of anger, and on promises to reopen coal mines and steel mills. Instead, he lowered taxes and interest rates, which was good for stocks. But that hasn’t helped people whose income and taxes are already low, who pay double-digit interest rates on credit cards, and who own few if any equities.

Another turning point

Bernie Sanders

Hence the return of demand-side economics. Also known as post-Keynesian economics or the (much maligned and misunderstood) Modern Monetary Theory, demand-side economics held sway from 1932 until 1971, when Richard Nixon abandoned the gold standard. Bernie Sanders is its atavistic avatar.

Demand-side is the flip-side of supply-side. Supply-siders and other neoclassical economists believe, for instance, that a higher minimum wage will lead to higher prices, layoffs, and a slowdown. Demand-siders and other “heterodox” economists believe that higher wages will lead to higher demand, more production, and more employment. They insist that less inequality means more prosperity for everybody, even the rich.

So if you hear Sanders fulminate about universal health care or free college, think “demand-side” economics. He’s addressing the same malaise that Trump exploited, but with a bottom-up solution that’s been out of favor for more than 40 years. Supply-side economics has been so dominant for so long, in fact, that you almost have to be Bernie’s age to remember that demand-siders once ruled the field.

© 2020 RIJ Publishing LLC. All rights reserved.

NAIC approves revised “best interest” rule for annuities

Posted on February 20, 2020 by -

In a meeting of the National Association of Insurance Commissioner (NAIC) Plenary last week, the association approved revisions to the Suitability in Annuity Transactions Model Regulation (#275), a February 13, 2020, NAIC release said.

The revisions clarify that all recommendations by agents and insurers must be in the best interest of the consumer and that agents and carriers may not place their financial interest ahead of in the consumer’s interest in making the recommendation. The model now requires agents and carriers act with “reasonable diligence, care and skill” in making recommendations.

“These changes underscore the commitment of U.S. insurance regulators to protecting consumers purchasing annuities,” said Ray Farmer, NAIC President and South Carolina Insurance Director. “Nearly every state has adopted the model, which has been protecting consumers for 15 years. I encourage my colleagues to work with their state legislatures to pass these updates to provide even stronger protection.”

The revisions incorporate a “best interest” standard into the model revisions that require producers and insurers to satisfy requirements outlined in a care obligation, a disclosure obligation, a conflict of interest obligation, and a documentation obligation. The model revisions also include enhancements to the current model’s supervision system to assist in compliance.

© 2020 RIJ Publishing LLC. All rights reserved.

Once scorned, FIAs are now embraced: Cerulli

Posted on February 20, 2020 by -

Fixed-indexed annuities (FIAs) made up nearly 57% of total annuity sales in 2019, climbing to a new all-time high of nearly $74 billion, according to Cerulli’s latest report, U.S. Annuity Markets 2019: Adapting to Financial Advisory Trends.

Favorable market conditions, growing acceptance from the broker/dealer (B/D) channels, and innovative product design features are factors that will contribute to further growth. By 2023, Cerulli predicts FIA sales will outpace those of the total retail variable annuity (VA) marketplace.

In sharp contrast to the steady outflows VAs have experienced since 2012 due to de-risking, FIAs are generating positive net flows. Bolstered by the overall performance of index strategies, as well as designs offering greater transparency (e.g., surrender charges, participation rates), FIAs allow insurers to both accumulate assets and keep assets in place to sustain profits. According to the report, FIAs should not be harmed greatly by Fed rate cuts, and if markets become volatile and or bearish, fixed annuities will once again serve as safe havens for risk-averse investors.

The repeal of the Department of Labor (DOL) Conflict of Interest Rule and passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act also contribute to Cerulli’s optimistic outlook.

“The threat of the DOL rule had been a key reason for reduced sales especially into VAs and FIAs. The passage of the SECURE Act may open the door for further growth,” said Donnie Ethier, director at Cerulli Associates, in a release this week.

The largest catalyst of growth comes from changing distribution dynamics. FIAs are accumulating assets at a solid pace for many B/Ds. The independent broker/dealer (IBD) channel experienced the largest 10-year gain in fixed annuity marketshare at nearly 8 percentage points; regional B/D marketshare has grown too, by almost 7 percentage points, according to the report.

“Broker/dealers have embraced the solution as products become more transparent and consumer-friendly,” said Ethier. “Investors value the product’s protection of principal coupled with tax-deferred growth of assets.”

The report finds that insurers are optimistic about the prospect of increased FIA sales within the independent agent and IBD channel—59% of insurers surveyed expect sales increases of 10% or more.

Insurers are innovating and appealing to B/Ds with tailored products. Cerulli expects this process will continue, if not accelerate.

“Insurers should continue to devise FIA features that will resonate with the B/D community and be open to developing fee-based models,” Ethier said, adding, “There will be a need for the solutions due to advisor migration to fee-based models and new regulations that should encourage—if not require—industry movement away from traditional upfront commissions.”

© 2020 RIJ Publishing LLC. All rights reserved.

Mike Bloomberg’s Retirement Security Plans

Posted on February 20, 2020 by -

“Social Security is under demographic pressure and needs shoring up for the long-term, but it faces no imminent crisis,” Democratic presidential candidate Michael Bloomberg’s campaign announced this week in a white paper titled, “Mike Bloomberg’s Retirement Security Policy.”

Bloomberg didn’t specify any tax increases, benefit cuts, or appropriations he might recommend for Social Security. With the senior population growing and the fertility rate falling, the 12.4% payroll tax that funds Social Security is projected to cover only 75% of promised benefits after 2034.

Although the former three-term New York City Republican mayor, billionaire, and founder of Bloomberg L.P. declared his candidacy late and missed the Iowa and New Hampshire primaries, he qualified for a spot in last night’s Democratic debate on the strength of a poll showing him with 19% support among Democrats and Democratic-leaning voters, according to a report yesterday in the New York Times.

Bloomberg’s proposals amount to far less than an overhaul of the U.S. retirement system, but some of them echo Obama-era initiatives that brought out opposition from private industry, such as:

  • A public-option national savings plan with a government match and annuitization
  • A $2,000 annual cap on personal expenses for prescription drugs under Medicare
  • A reduction in tax benefits in 401(k) plans for high-income savers
  • Recommendations for simpler reverse mortgages
Social Security

Any privatization of Social Security that would shift a portion of contributions into the stock market was absent from Bloomberg’s proposals, which instead included:

  • A new minimum benefit that could lift about 10% of current recipients out of poverty, replacing the Supplemental Security Income program, which the whitepaper called complicated, under-used, and insufficient
  • Higher cost-of-living (COLA) adjustments that reflect seniors’ high level of exposure to health care cost inflation
  • Higher benefits for low-wage family caregivers, and a remedy for the fact that surviving spouses lose up to half their benefits without a commensurate drop in expenses
Tax-deferred retirement savings plans

Bloomberg favors a national savings program for workers without tax-deferred retirement savings plans at work, modeled on the Thrift Savings Plan for federal government workers. The program would include a government match paid for with “a reduction in the tax break for high-income retirement plan contributions.”

The new savings plan would:

  • Automatically invest savings in an appropriate target-date fund and provide savers with prudent alternatives
  • Auto-enroll savers in a low-cost, inflation-indexed annuity at retirement age
  • Allow savers to consolidate all of their retirement savings in one public-option account
  • Designate a small part of the accounts as an emergency fund, which savers can tap for short-term needs without a penalty.
Medicare and Medicaid
  • A cap on Medicare beneficiaries’ out-of-pocket drug spending at $2,000 per year
  • Costs above a “catastrophic threshold,” now paid by Medicare, would be shared among Medicare (20%), drug manufacturers (via a 30% discount) and the participant’s drug plan (50%).
  • A federal safety net to insure against catastrophic long-term care costs, in response to weakness in the private long-term care insurance market.
  • New programs at the state level to deliver support services to those needing long-term care at home.
  • Dental, vision and hearing care for older Americans via Medicare benefit, similar to the drug benefit, to cover those services. Beneficiaries would pay a separate premium of roughly $25 and low-income beneficiaries would receive premium subsidies.
Reverse mortgages

The candidate said he favors:

  • Simpler and less-expensive products
  • Strong advisory services to improve financial literacy pre-retirement
  • Education for financially-stressed seniors explore their options
  • Federally-subsidized loans for qualifying low-income seniors
  • State programs allowing low-income seniors to defer property taxes on their homes, leaving them with more income to live on

© 2020 RIJ Publishing LLC. All rights reserved.

 

Annuity sales reach 12-year high in 2019

Posted on February 20, 2020 by -

Total annuity sales for 2019 were $241.7 billion, up 3% from 2018 and the highest annual annuity sales recorded since 2008, according to the Secure Retirement Institute’s (SRI) Fourth Quarter U.S. Annuity Sales Survey. Sales in the fourth quarter were $57.6 billion, down 8% from 4Q2018.

The positive numbers were driven by sales of deferred fixed rate and fixed indexed annuities, which together represented 58% of annuity sales in 2019. Total fixed sales in 2019 were $139.8 billion, up 5% from 2018. That broke the previous record of $133.5 billion despite a weak fourth quarter when sales dropped 18% to $30.8 billion.

“Fixed annuity sales have driven the overall growth for the annuity market over the past four years,” said Todd Giesing, director, Annuity Research, SRI (formerly LIMRA SRI), in a release. “Much of the overall growth in the fixed market can be attributed to the continued growth in the fixed indexed annuity market (FIA).

“FIA sales have increased 11 of the past 12 years, accounting for more than half of the fixed annuity market sales,” he added. For the year, FIA sales were $73.5 billion, up 6% from 2018 results. This surpasses the sales record for FIA sales set in 2018.

“Falling interest rates in the third quarter dampened fixed product sales in the second half of the year,” Giesing said. “Most fixed products experienced declines in the fourth quarter, pulling down total annuity sales results for the quarter.”

In the second half of 2019, Federal Reserve chair Jerome Powell announced three quarter-point cuts in the benchmark Fed funds rate. President Trump had openly pressured Powell for looser monetary policy despite the apparently booming U.S. economy. Rate cuts generally help the stock market but hurt the annuity market.

In the fourth quarter, FIA sales were $16.9 billion, down 13% from prior year’s results. SRI researchers attributed the drop to low interest rates and competition from registered index-linked annuities, which offer a similar value proposition.

Fee-based indexed annuity sales continue to fall. In the fourth quarter, fee-based FIA sales were $140 million, down 17% from prior year. Even though fee-based products represent less than 1% of the total FIA market, this trend bodes poorly for life insurers, who are eager to grow sales among the growing numbers of advisers who charge only for advice and don’t sell products or take commissions from annuity issuers.

Fixed-rate deferred annuity sales dropped 29% in the fourth quarter to $9.4 billion. But thanks to a strong first half, fixed-rate deferred annuity sales totaled $47.5 billion for the year, up 4% from 2018. This is the highest level of fixed rate deferred sales since the financial crisis.

Single premium income annuity (SPIA) sales were $9.9 billion in 2019, up 2% from the sales record set in 2018. The record sales came despite a drop of 22% in the fourth quarter, to $2.1 billion. Deferred income annuity (DIA) sales fell 20% in the fourth quarter, to $527 million. For the year, DIA sales totaled $2.5 billion, up 8% from 2018.

For the third consecutive quarter, variable annuity (VA) sales recorded positive growth. VA sales were $26.8 billion in the fourth quarter, up 8%, from 2018. VA sales were $101.9 billion for the year, up 2% from 2018. This is the second consecutive year of annual growth.

Sales of registered index-linked annuity products (RILAs) drove growth in the VA market. In the fourth quarter, RILA sales were $4.9 billion, 39% higher than in the same period in 2018.

“When you look at VA sales excluding RILAs, VA sales dropped 5% in 2019, compared to the 8% increase recorded with RILAs included,” said Giesing. “One driver of growth in the RILA market is GLB riders. More than $400 million of fourth quarter RILA sales were with GLB riders, representing 8% of the total RILA market.” In 2019, RILA sales were $17.4 billion, representing 17% of the VA market.

Fee-based VA sales were $850 million in the fourth quarter, 5% higher than prior year. This matches the record sales experienced in the second quarter 2018. For the year, fee-based VAs totaled $3.0 billion, which is 5% lower than 2018 results. Fee-based VAs represent just 3% of the total VA market.

© 2020 RIJ Publishing LLC. All rights reserved.

Ask the Wizard: Can I Retire?

Posted on February 20, 2020 by -

Retirement readiness calculators are back in the news, thanks to a provision in the SECURE Act that requires retirement plan sponsors to send participants an annual “lifetime income disclosure” that would show how much monthly income their savings would generate in retirement.

That monthly dollar figure would be based on the monthly payout from a SPIA (a single premium immediate annuity, single life or joint and survivor) that the participant would purchase at retirement with his or her entire account balance.

Another provision of the Act orders Secretary of Labor Eugene Scalia to write a “model disclosure” to serve as a standard for projecting and reporting monthly incomes. The SECURE Act also exempts plan sponsors from liability for participant misuse of that information, as long as they use the standard.

The idea for disclosing future income estimates to 401(k) participants has kicked around since the mid-Obama administration. Behavioral finance and “nudges” were in the air. Experts agreed that if 401(k)s were to replace pensions, then people should start viewing their 401(k) balances through a prism of monthly income.

The Department of Labor has offered an online calculator since 2012. It more or less takes your current 401(k) balance, grows it by 4% a year (7% growth minus 3% inflation), and spits out a hypothetical annuity quote (monthly income, in today’s dollars).

Not ideal

This government-issue calculator is quite simple and easy to use, and it was offered as a model for 401(k) plans when it was created. But it assumes that plan participants purchase a SPIA. In practice, very few participants buy, intend to buy, are encouraged to buy, or will be required to buy a fixed annuity with even half of their savings, let alone all of it.

(The DOL does offer a detailed online questionnaire/calculator and a 68-page workbook, “Taking the Mystery Out of Retirement Planning,” but their purposes are different from the kind of brief annual disclosure that’s contemplated for 401(k) participants.)

Another problem: You can’t assess a household’s retirement readiness using only one person’s current 401(k) balance. Even as a crude benchmark, it’s as likely to scare people (when they see how underfunded they are) as it is to encourage them to save more.

So, as the Secretary of Labor works on the new disclosure, we decided to survey half a dozen private sector calculators for ideas that the DOL might use to make the disclosure more useful, but still simple.

RIJ played mystery-shopper and test-drove half a dozen online calculators. From countless eligible candidates, we chose those at Fidelity, Vanguard, Schwab, Pacific Life, New York Life and the Alliance for Lifetime Income, which is the retirement industry’s non-profit “protected lifetime income” education group.

As we knew they would, different wizards yielded different outcomes, depending on their assumptions. Some assume a classic 4% withdrawal rate. Others assume a life annuity rate, which pays out about 6%. Some calculators seek input on only one person, others about couples.

Hypothetical inputs

To fill the data fields on each wizard, we assumed the following hypothetical couple:

  • A 50-year-old primary worker, earning $100,000/year
  • A 50-year-old secondary worker, earning $50,000/year
  • No defined pension or existing annuity
  • Moderate risk tolerance (60% equities)
  • $150,000 saved so far by the primary worker; savings rate $6,000/year
  • $75,000 saved by the secondary worker; savings rate $4,000/year
  • Target retirement ages of 67
  • A home worth $250,000 with $100,000 left on the mortgage
  • A retirement length of 25 years
  • No known inheritance
  • Zero non-mortgage debt (for simplicity)

We thought that a single 50-year-old American earning $100,000, with savings of $150,000 and new contributions of $6,000 a year (or a two-income household earning $150,000, with $225,000 saved and contributions of $10,000 a year) would surely be “on track” for retirement. Those numbers put them in the top 15% of Americans, money-wise.

Vanguard Retirement Income Calculator

A major retirement plan provider, Vanguard may have designed this wizard for its plan participants. It asks for only one person’s information, uses a conservative 3% withdrawal rate (4% minus inflation) and suggests an 85% replacement rate (i.e., a retirement income equal to 85% of pre-retirement income). It asks the user for an expected asset growth rate for the $150,000 in savings plus future contributions. We input “5%.” The wizard reduced it automatically to 4% for inflation and got $440,000.

In our case, the wizard said we’d need a pre-tax $7,083 per month (in current dollars) in retirement, but have only $4,099. That included our estimate of $3,000 from Social Security and $1,100 from investments (3% of $440,000).

If we used the tool’s handy sliders and shoehorned in the second earner’s salary ($50,000) Social Security ($1,500) and savings ($4,000 per year; $75,000 accumulated) to the equation, assumed a 6% growth rate and 70% replacement rate, the expected monthly income rose to $6,463, but the monthly need became $8,750, based on the higher income ($150,000). To achieve that income, the couple would need to save $41,000 every year for the next 17 years.

Pacific Life Retirement Income Translator

Pacific Life’s wizard compares the advantage of a life annuity over the 4% rule. Based on our primary earner’s $150,000 in savings today, the calculator estimated savings of $435,231 by age (67). Assuming a 6% return, 2% inflation, and a 4% withdrawal rate, the wizard projected total income of $675,343 over 28 years (to age 95).

The wizard highlighted the fact that the total retirement income would be $822,506 if the investor bought a single premium income annuity (SPIA) at retirement, or $147,163 more than the 4% rule provided. Pacific Life assumed a 3% internal rate of return. (Interest rates and annuity payouts have declined since the Pacific Life wizard was created.)

Fidelity Retirement Score

From Fidelity

Fidelity’s calculator needed six pieces of information to create a retirement readiness score. Along with age, current salary, accumulated savings, and monthly savings rate, it asks if the investor intends to spend more or less in retirement than he or she currently does. (We chose “less.”) The wizard assumes when the person reaches age 65 he’ll claim $2,114 in monthly benefits and that he’ll live to age 93.

The calculator offered nine risk profiles, from “Short-Term” (all cash) to “Most Aggressive” (all stocks). He chose “Balanced,” which allocated 50% to stocks, 40% to bonds and 10% to cash.

He scored a dismal 48 on a scale where 100 represented full funding. His projected monthly income of $3,447 (including Social Security) would fall far short of his estimated pre-tax need of $7,185.

Using the digital toggles on the web page, the investor could score 73 (a solid “C”) by saving $1,000 a month, retiring at age 67, reducing retirement expenses by 15%, and allocating 60% to equities.

But his new income of $4,596 would still be $1,700 a month (27%) shy of security. By retiring at age 67 and adding his wife’s savings and Social Security benefit, the couple might squeak through—if they could “live as cheap as one.”)

Schwab Retirement Calculator

Schwab asks for current age, income, expected age of retirement, risk tolerance (five options, from Low to High), Social Security claiming age, savings rate, current savings amount and—this was unusual—“Supplemental Income in Retirement.” This question allowed the user to report rental income or a spouse’s income during the primary earner’s retirement. The wizard calculated the Social Security benefit automatically. When prompted, we stipulated a 70% replacement rate instead of estimating the couple’s retirement expenses.

The calculator estimated that the saver would need savings of $1.36 million by age 67 but would have only $610,000 saved by the retirement date. Dauntingly, the wizard suggested that the investor retire at age 76, start saving $27,000 per year, or cut retirement spending to $44,600 per year. It offered sliders to adjust age of retirement, savings rate, and retirement spending rate. If we added the secondary earner’s savings and Social Security benefit, and set the couple’s spending at $60,000 in retirement, then a secure retirement appeared within reach.

New York Life Retirement Savings Calculator

New York Life’s calculator is built for a couple. It provides fields for partner’s income, accumulated savings and annual savings rate. The wizard self-calculates the couple’s combined Social Security income. We entered 5% for expected rate of return, 25 years for expected length of retirement, and a 70% replacement rate. ).

From New York Life

Based on our couple’s data, the calculator estimated their total savings at retirement of $792,633 and a combined Social Security income of $74,823. To reach the 70% desired replacement rate, the couple would have to save an additional $1,866 a month over the next 17 years. By cutting their replacement rate to 60% and doubling their savings rate to $20,000, the couple would be assured an adequate income to age 92, with some $642,577 left over. New York Life had assumed annual increases of 2% and 1%, respectively, in salaries and savings rates. Taxes were left out of the model. (New York Life has another online calculator for 401(k) clients, but it doesn’t appear geared to retirement income adequacy.)

Alliance for Lifetime Income Retirement Income Security Evaluation (RISE)

Life insurers and asset managers started the Alliance for Lifetime Income in 2018 as a non-profit vehicle for educating the public about annuities. Its calculator, like Fidelity’s, produces a score. Like New York Life’s, it accommodates couples or singles.

Our hypothetical couple’s inputs ($225,000 in current savings, $10,000 saved per year, $4,500 in combined Social Security benefits, monthly expenses of $6,000 in retirement, and a 20% allocation of savings to an unspecified annuity) earned them a score of only 398 on a scale of 800. That was “Poor.”

“The expected income in retirement, including portfolio withdrawals, may cover 73% of expenses in average scenarios and 59% of expenses in the worst 10% of scenarios,” the Alliance’s calculator showed. Milliman, the global actuarial consultant, engineered this wizard.

According to a disclosure sheet, this wizard modeled annuity-related results using deferred variable annuities, and fixed indexed annuities with guaranteed lifetime withdrawal benefits, as well as SPIAs. This was the only calculator that modeled all of the types of deferred annuity products that life insurers are likely to offer plan participants under the SECURE Act.

Takeaways

Our hypothetical couple turned out to be much less prepared for retirement than we expected. Every calculator found them deeply underfunded. Yet this imaginary couple is far better off than most. The median 401(k) balances among Vanguard plan participants for those ages 45 to 54 is $40,243, according to Vanguard research. The average balance, which by rule of thumb represents roughly the 75th percentile, is only $115,497 for that age bracket.

Our exercise was educational, however. A simple annual “disclosure” of future income based on one person’s retirement plan balance—which Congress has asked the Department of Labor to create this year—might be worse than useless. (See the Anecdotal Evidence column in today’s issue of RIJ.) Calculators should accommodate the incomes and savings of a couple, as well as individuals. “Sliders” that allow participants to adjust their inputs will be essential for motivating people and enabling changes in savings habits. Otherwise, a secure retirement may look discouragingly out of reach.

© 2020 RIJ Publishing LLC. All rights reserved.

Divorces over 50 roil estate planning

Posted on February 13, 2020 by -

“Gray divorce,” which refers to the increasing rate of divorce for those over 50 years old, along with prolonged life expectancy and rising healthcare costs, is having an impact on financial planning, specifically estate planning, according to TD Wealth, a unit of TD Bank.

A survey conducted by TD Wealth at the recent 54th Annual Heckerling Institute on Estate Planning found that 40% of respondents, comprised of estate planners and attorneys, said that gray divorce is causing a rise in family conflict, a significant challenge in estate planning. The institute is part of the University of Miami School of Law.

“Gray divorce is adding another layer of complexity to the estate planning process that already arises with blended families, designation of heirs and the ever-changing domestic structures,” said Ray Radigan, Head of Private Trust at TD Wealth, in a release.

Of those responding to the survey, 39% identified retirement planning and funding as a highly impacted factor of estate planning for those divorcing over the age of 50. Gray divorce is also having an impact on determining who will be responsible for enacting power of attorney, determining appropriate social security benefits, and drafting of a will.

The TD Wealth survey also found that “not communicating the estate plan with family members”” is the most common cause of conflict (43%), followed by dealing with blended families” (29%). Only 13% of respondents cited designation of beneficiaries as a cause for conflict in 2020, down from 30% a year ago.

For two consecutive years (2018 and 2019), the survey showed that family conflict was the leading threat to estate planning. In 2020, equal numbers of estate planners expressed concern over family conflict (25%); tax reform (25%); prolonged life expectancy and increased healthcare costs (25%).

A large share of estate planners said they are reconsidering the implementation of traditional strategies to work with the gift exemption under the Tax Cuts and Jobs Act, rather than treat it as an obstacle.

Thirty-nine percent (39%) of respondents suggest to clients to gift now when the exemption is high. However, 23% of respondents suggest advising clients to consider trusts to protect assets from future claims, and 20% suggest planning to minimize future capital gains tax consequences.

“Even though there is a higher exemption on gifting now, we are advising some clients to consider retaining more now because people are living longer, and those associated costs are impacting their estate plans,” Radigan said.

The total sample included 112 survey respondents who attended the 54th Annual Heckerling Institute on Estate Planning, including attorneys, trust officers, accountants, charitable giving professionals, insurance advisors, elder law specialists, wealth management professionals, educators and non-profit advisors. The survey was fielded January 13-14, 2020.

© 2020 RIJ Publishing LLC. All rights reserved.

T. Rowe Price adds growth to its TDFs

Posted on February 13, 2020 by -

T. Rowe Price Group, one of the “big three” target date fund issuers (along with Fidelity and Vanguard), announced in a release this week that, over a two-year period, it will “gradually increase equity exposure in the Retirement and Target portfolios’ glide paths early in the accumulation years and post-retirement and add emerging markets and U.S. large-cap core equity strategies to further diversify the underlying investments.”

Such enhancements, based on proprietary research, “are designed to help improve retirement outcomes and address the headwinds investors face in achieving retirement security, including longevity risk, inflation risk, and market risk,” the release said.

T. Rowe Price’s research finds that “outcomes in retirement may be improved by adjusting the amount of growth-seeking assets in the longer (pre-retirement) and shorter (post-retirement) ends of the glide path without increasing the level of risk at retirement. For example, raising equity levels led to higher average balances at retirement, more sustainable levels of income and consumption replacement, and greater residual wealth,” the release said.

Based on T. Rowe Price’s research, the following changes will be made:

Retirement glide path

  • Raise the equity allocation of the glide path at the start of the investing lifecycle (30 or more years from retirement) to 98% equity from the current 90% equity
  • Hold the 98% equity allocation constant until 30 years from retirement
  • Maintain a 55% equity allocation at retirement
  • Raise the equity allocation after retirement, reaching a final 30% equity allocation 30 years past retirement, an increase from the current 20% allocation

Target glide path

  • Raise the equity allocation of the glide path at the beginning of the lifecycle to 98% equity from the current 90% equity
  • Hold the 98% equity allocation constant until 35 years from retirement
  • Maintain a 42.5% equity allocation at retirement
  • Raise the equity allocation after retirement, reaching a final 30% equity allocation 30 years past retirement, up from the current 20%

The transition will occur over a two-year period starting in April 2020. Portfolios closest to retirement will not experience an increase in equity from their current levels, while other vintages/dates will adjust their equity allocations gradually each quarter.

As a result, many investors will see no change to their current equity allocation. The firm believes these updates will help preserve the wealth investors have worked hard to build while seeking growth, both in the early accumulation years and post-retirement, to help preserve spending power and keep pace with inflation.

Building-block additions

T. Rowe Price also announced the addition of two investment strategies to the underlying building-blocks of several target date products:

Emerging Markets Discovery Stock will be added to all the firm’s target date strategies

U.S. Large-Cap Core will be added primarily to actively managed strategies (Retirement Funds, Retirement I Class Funds, Retirement Income 2020 Fund, Retirement Trusts, Target Funds, and Target Trusts).

Adding the Emerging Markets Discovery Stock further diversifies target date portfolios’ existing exposure to emerging markets stocks. U.S. Large-Cap Core helps diversify strategy concentration in longer-dated portfolios and reduces the concentration of S&P 500 exposure in the shorter-dated portfolios.

Mutual fund fee structure changes

For its Retirement and Target mutual funds, T. Rowe Price is moving to a unitary, top-level fee structure in which expense ratios will no longer vary depending on the management fees and expenses of the underlying funds.

This modification provides shareholders a simplified fee approach across the firm’s target date mutual funds that provides greater predictability around the fees they will pay. The new fee structure will be implemented in April 2020. There are no current plans for pricing changes on collective investment trusts (CITs) or other vehicles.

As a result of this change, none of the firm’s target date portfolios will experience an increase in expense ratios, and some will see their expense ratios decrease.

According to an article in PlanSponsor magazine, “Vanguard, which managed 33.6% of TDF assets in 2017, has grown to control 37.8% of the marketplace. The four next-biggest providers are Fidelity, which controlled 21.2% of assets in 2017 versus 19.4% in 2019; T. Rowe Price, controlling 16.4% in 2017 and 12.4% in 2019; American Funds, managing 7.2% in 2017 and 10.5% in 2019, making it the only other top-five provider besides Vanguard to gain market share; and J.P. Morgan, which managed 5.0% of TDF assets in 2017 and now manages 4.3%.

All other TDF providers manage 15.6% of the marketplace—down from 16.6% in 2017. The other largest providers include Nuveen/TIAA, BlackRock, Principal Funds and John Hancock Investments.

© 2020 RIJ Publishing LLC. All rights reserved.

Why Does a Great Economy Need Financial Aid?

Posted on February 13, 2020 by -

In President Trump’s “State of the Union Address” last week, he talked up his achievements in the economy and the markets, including:

  • Low unemployment rates
  • Tax cuts
  • Job creation
  • Economic growth
  • Record-high stock markets.

While he can claim credit for most of the items on this list, his claim of record-high stock prices undermines the rest of the story. Let me explain.

The stock market should reflect actual economic growth. Corporate earnings are derived primarily from

  • Consumptive spending
  • Corporate investments
  • Imports and exports

Economic activity should therefore determine the price investors are willing to pay for the earnings being generated.

For the majority of the 20th century, this was indeed the case. Corporate earnings reflected economic activity. The economy grew at 6.47% annually and earnings grew at 6.68% annually. Since investors will pay a premium for earnings growth, the S&P 500 grew at 9% annually over that same period.

But economic growth has been running below the long-term average since 2000. The economy has grown at just 2% annually since 2007.

Artificial stimuli

If that’s true, why is the S&P500 Index at a record deviation from that growth? A decade of accounting gimmickry, share buybacks, wage suppression, low interest rates, and high corporate debt levels explains it.

If consumer spending is strong, and unemployment is near the lowest levels on record, and interest rates are low, and job creation is high, why is the economy growing at only 2%? Why do we need deficit spending and Federal Reserve need to provide “emergency measures” to prevent the markets from crashing?

Because, otherwise, the economy would be in recession.

In GDP accounting, consumption is the largest component. Our high rate of consumption has come from growing debt, however. Government spending (transfer payments such as Medicaid, Medicare, disability payments, and SNAP or food stamps) all contribute to the calculation.

But it is impossible to “consume oneself to prosperity.” Transfer payments may boost GDP, but they produce nothing and drive up the national debt. If the economy were “the strongest ever,” wages and tax receipts would be rising. Instead, since peaking in 2012, tax receipts have declined to recessionary levels.

The inevitable reversion to the mean

These artificial interventions have allowed the stock market to remain detached from underlying profitability. This guarantees poor future outcomes for investors. The markets can “remain irrational longer than logic would predict,” but not indefinitely. Peaks (and subsequent reversions) in the profits-to-GDP ratio have been a leading indicator of severe corrections in the stock market over time.

Investors may hope that as long as the Fed supports asset prices, the deviation between fundamentals and fantasy won’t matter. But investors are paying more today than ever for each $1 of profit, and history suggests it will not end well. Asset prices will eventually reflect the underlying reality of corporate profitability.

There’s political risk for President Trump in taking too much credit for an economic cycle that was well into recovery before he took office. Rather than tout the economic numbers and financial asset prices, he should use that strength to end the government spending-binge and return the country to fiscal discipline.

Politicians, over the last decade, could have used the liquidity injections, near-zero interest rates, and surging asset prices to refinance the welfare system, balance the budget, and prepare for the next downturn. Instead, the U.S. economy will enter the next recession with a $2 trillion deficit, a $24 trillion national debt, and a $6 trillion pension gap.

Donald Trump criticized “Yellen’s big fat ugly bubble” before he took office, but he has bet his presidency on the stock market. He’s likely to regret it.

© 2020 Realinvestmentadvice.com

A longer version of this blogpost, including charts, can be found here: https://realinvestmentadvice.com/sotm-2020-state-of-the-markets/

 

Research Roundup

Posted on February 13, 2020 by -

Last year, a dark book justly titled “Darkness by Design” (Princeton, 2019), warned that the equity trading world we grew up with—one dominated by the New York Stock Exchange and kept more or less honest by its human market-making “specialists”—has all but vanished.

The author, Oxford political economist Walter Mattli, documents the advent since 2000 of a very different trading world—one that’s fragmented, opaque, and algorithm-driven. It’s a world of high-speed institutional trading and “dark pools” run by and for insiders to the detriment of individual investors.

Mattli makes a powerful (and scary) case. But a new paper from the National Bureau of Economic Research (NBER Working Paper 26147), “The Value of Intermediation in the Stock Market,” by Mark L. Egan and Marco Di Maggio of Harvard Business School and Francesco Franzoni of the Swiss Finance Institute, tells a slightly different story.

Human intermediation still exists, they write—at least for institutional investors. Studying over 300 million institutional trades, the three economists found that “more than half of all institutional investor order flow is still executed by high-touch (non-electronic) brokers… Trading is and always has been a relationship business.”

While Mattli emphasizes the arms race in electronic trading speeds, Egan et al found that “Investors prefer to trade with equity traders located in the same city as the investor. Even though the equity orders are placed either electronically or over the phone, physical proximity to the broker influences an investor’s trading decisions.”

Large investors are less interested in fundamental research on stocks than in order flow information, the NBER authors found. Such information helps them avoid moving the market ahead of a large trade or, conversely, helps them anticipate other investors’ large trades and buy or sell ahead of it.

“Hedge funds appear to place a premium on the other types of information produced by brokerage firms, such as whether or not the broker has access to informed order flow,” Egan et al found.

Where Mattli finds that brokers worry less about protecting their personal and professional reputations today, in part because they are employees rather than partners in small firms, Egan et al found that reputation matters to investors.

“A one percentage point increase in the number of traders engaging in misconduct (roughly one additional trader for a median-sized brokerage firm) is associated with a 2% decline in the brokerage firm’s trading volumes,” they write.

Dynastic Precautionary Savings

Uncertainty about a child’s success or failure in adulthood may determine how much the parents try to save during their own working years and how much they refrain from spending in retirement.

That statement may seem obvious, given most parents’ natural concern for their children. But new research suggests that this motive may be stronger than the usual explanations for frugality among retirees, such as their desire to hoard money against the risk of living too long or needing long-term care.

New York University economist Corina Boar calls this type of thrift, “Dynastic Precautionary Savings,” in her paper of the same name (NBER Working Paper 26635). She claims that parents generally create and keep a safety net for their children from roughly the time children enter the workforce until the parents die, about 30 years later.

“Parents of children younger than 40 consume on average $2,528 less per year because at that stage most of children’s income uncertainty is yet to be resolved,” Boar writes. “Holding everything else equal, the consumption of a parent whose child is a construction worker is 2.5% lower than the consumption of a parent whose child is a services worker because of the dynastic uncertainty difference.”

Boar’s theoretical model predicts that “16.7% of total wealth is held for dynastic precautionary reasons, and that children’s income risk is the main driver of intergenerational transfers.” It also predicts that this parental savings accounts for about one-fourth of the adult children’s own cushion against a big drop in income.

Unintended Consequences of a Declining Population

It’s America’s low fertility rate, not just the jumbo size of the baby boom generation, that’s causing fiscal imbalances in government programs, demographers will tell you. Falling fertility and shrinking populations is, in fact, expected to act as a drag on economic growth in all of the wealthy industrialized countries.

“The emergence of negative population growth in many countries… has profound implications for the future of economic growth,” writes Charles I. Jones of Stanford’s Graduate School of Business in his new paper, “The End of Economic Growth? Unintended Consequences of a Declining Population” (NBER Working Paper 26651, January 2020).

In Jones’ view, we’re nearing a tipping point on declining human replacement rates. “If society waits too long to adopt good institutions, the optimal allocation switches from one of sustained exponential growth in population, knowledge, and living standards to one of stagnation and an empty planet,” he warns.

Long-term improvement in living standards could depend on whether a smaller population can manage to generate the innovation needed to deal with future economic threats. Jones ends with a suggestion that automation—perhaps artificial intelligence—could offset the reduced number of human innovators.

Unhappiness and Age

People in their 50s—those bearing the most responsibility, debt, and dependents—are less happy than people younger or older, according to David G. Blanchflower, an economist at Dartmouth College. In “Unhappiness and Age” (NBER Working Paper 26642), he writes, “There appears to be a midlife crisis.”

Blanchflower gathered data on fifteen different aspects of unhappiness among nearly ten million respondents across forty European countries and the United States. Those aspects included “despair; anxiety; loneliness; sadness; strain, depression and bad nerves; phobias and panic; being downhearted; having restless sleep; losing confidence in oneself; not being able to overcome difficulties; being under strain; feeling a failure; feeling left out; feeling tense; and thinking of yourself as a worthless person,” according to the paper.

While there has always been a midlife crisis, Blanchflower believes, the 2008 Great Financial Crisis made the situation worse, especially for people living in rural areas, dependent on manufacturing jobs, and with less than a college education. Urban areas bounced back after the crisis, but mortality rose in rural areas. “The death rate in rural areas from heart disease, cancer, unintentional injury, chronic lower-respiratory disease, and stroke” was much higher than in urban areas.

While the age-adjusted suicide rate in urban counties in the U.S. rose 16% between 1999 and in 2017, it rose 53% in rural counties, Blanchflower’s data shows. By 2017 the suicide rate in rural counties (20 per 100,000) was nearly double that of urban counties. Drug-overdose death rates were higher in cities in 1999, but by 2015 it was higher in rural areas.

Linking his findings to the political arena, Blanchflower asserts that President Donald Trump in the U.S. and Prime Minister Boris Johnson in the U.K. recognized this despair and leveraged it into political victories. “Areas that were left behind voted for Trump and Brexit,” the paper says. “In both instances the votes for change were positively correlated with the unemployment rate, low life expectancy, drug use, the smoking rate, the obesity rate and how poor the area was.”

Why Are 401(k)/IRA Balances Substantially Below Potential?

While 401(k) retirement plans have helped millions of workers amass trillions of dollars in wealth over the past 35 years or so, millions of participants in those plans fail to accumulate enough savings by age 65 to finance their retirements.

In a recent paper, “Why Are 401(k)/IRA Balances Substantially Below Potential?” Alicia Munnell and Anqi Chen of the Center for Retirement Research at Boston College, and Andrew Biggs of the American Enterprise Institute quantify and explain that failure.

“Most workers have 401(k)/IRA balances at retirement that are substantially below their potential,” they write. “For example, a 25-year-old median earner in 1981 who contributed regularly [6% of pay with a 3% employer match] would have accumulated about $364,000 by age 60, but the typical 60-year-old in 2016 had less than $100,000.”

They identify four drivers of this shortfall—the fact that the 401(k) system is relatively new, the fact that people don’t always work for an employer that offers a 401(k) plan, so-called “leakage,” which refers to withdrawals from plan balances during job-changes, and fees that act as a drag on accumulation.

Of those factors, immaturity of the 401(k) system is the biggest problem, they found. On average, it shaves $116,200 off the $364,000 ideal accumulation. Inconsistent contributions, which is related to the “coverage gap” (only about half of workers have access to a plan at any given time), reduces accumulations by another $111,600.

Leakage and fees have less of an impact. Leakage—hardship withdrawals, for instance—reduces the ideal balance by $30,600. Fees, which have fallen in recent years, reduce the ideal balance by only $13,400, the authors found.

© 2020 RIJ Publishing LLC. All rights reserved.

Roth 401(k)s: Appealing but Impractical

Posted on February 13, 2020 by -

The lives of retirees would probably be simpler if Roth IRAs and Roth 401(k)s replaced tax-deferred traditional IRAs and 401(k)s. Minimum annual distributions (“RMDs”) after age 72 (under the new tax rules) wouldn’t be necessary, and retirees would be relieved of the tax bills that the annual distributions bring in their wake.

Nor would anyone feel compelled to convert a traditional IRA to a Roth IRA—a labor-intensive process often recommended to high net worth retirees as a way to minimize taxes in retirement.

Economists Stephen Zeldes of Columbia University and Mattia Landoni of Southern Methodist University suggest another reason for switching to an all-Roth regime. (Read their paper here or here.)

These two economists observe that tax deferral has caused the accumulation of $3 trillion of additional assets (the present value of taxes on future RMDs) into 401(k)s and traditional IRAs, including rollover IRAs. The money is there, in effect, because the government hasn’t taken taxes out of it yet. In the two economists’ opinion, the government is paying too much in fees on that money.

Zeldes and Landoni calculate that if Roth 401(k)s and Roth IRAs replaced the status quo, or if the government paid institutional-level fees on its investment in 401(k)s and IRAs, the government would save enough money to give every saver a 6% match on their contributions.

“We estimate that tax deferral increases demand for asset management services by $3 trillion, causing the government to pay $20.7 billion [per year] in corresponding annual fees. Tax deferral in our model produces a larger asset management industry, higher taxes, and lower social welfare,” Zeldes and Landoni write.

I agree that tax deferral creates complexity, and that the savings from federally-enhanced economies of scale should benefit individual investors, not intermediaries. But the retirement industry has consistently fought to preserve the status quo, for the same reason the two economists want to change it.

The benefits of the current system to the retirement industry are huge, if difficult to calculate precisely because of feedback effects. To get a handle on it, I look at the estimated “tax expenditure” for individual and group retirement—the taxes the government doesn’t collect on contributions or gains—and assume that it translates into extra assets under management and fee revenue that the financial industry would not have received in the absence of tax deferral.

For the five year period, inclusive of years 2019 through 2023, the Joint Committee on Taxation estimates that the tax expenditure for defined contribution plans will be $775.6 billion, while the tax expenditure for traditional IRAs will be $100.9 billion and for Roth IRAs $44.5 billion. The Center for Retirement Research at Boston College recently calculated that fees reduce 401(k) account balances by about 10%. Fees on rollover IRAs at brokerage firms may be higher than fees in 401(k) plans.

(In their model, Landoni and Zeldes assume that the foregone taxes for Roth IRAs and traditional IRAs end up the same in the long run. That’s why they prefer to focus on the impact of fees, where a switch to Roth accounts would be demonstrably cheaper for the government.)

Ironically, it’s their lack of RMDs, which are desirable for the owner, that disqualifies Roth accounts as an viable alternative to traditional accounts under current law. Lack of RMDs makes Roth accounts effective vehicles for inter-generational transfers, but not good vehicles for the provision of retirement income.

Here’s why. If the public policy goal of tax deferral (and the tax expenditures associated with it) is to help people generate more income during retirement, then RMDs are essential to the achievement of that goal. They force the quasi-annuitization of savings and discourage retirees from using tax-deferred accounts for bequests. Ultimately, the government hopes that, if more Americans save, fewer will become dependent on government entitlement programs in their old age. There’s a method to the madness.

Landoni and Zeldes suggest that non-taxable RMDs could be added to Roth accounts to help achieve the policy goal described above. But that would remove a selling point of Roth accounts—flexibility in taking distributions. Financial advisers like the flexibility of a Roth. They have long advised retirees to tap tax-free Roth IRAs last—after spending down taxable and tax-deferred assets. Such delays naturally increase the chance that a Roth IRA will pass to a beneficiary.

Many people glibly say that RMDs exist because “the government wants its money back.” I doubt it. The federal government has shown that it can create all the money it needs whenever necessary. If Uncle Sam were so desperate for our tribute, you would see revenue agents going house-to-house every spring, demanding every last nickel or dime.

You might even see angry taxpayers pour boiling water on the tax collectors’ heads from second-story windows—as happened in my own neighborhood during the John Fries tax rebellion of 1798.

© 2020 RIJ Publishing LLC. All rights reserved.

MassMutual to offer student debt relief program

Posted on February 6, 2020 by -

Massachusetts Mutual Life Insurance Company (MassMutual) is offering a student loan refinancing program through the workplace retirement plans it administers. The program is provided through a fintech firm, CommonBond, and will be available to some 2.6 million participants.

Last year, MassMutual began offering CommonBond’s refinancing program through the insurer’s 8,500 plus network of financial advisers.

An estimated 44 million Americans owe $1.5 trillion in student loan debt, according to the Federal Student Aid Office of the U.S. Department of Education, a MassMutual release said. Debt burdens vary widely but that figure implies an average debt of $37,000 per person and a monthly payment of $393.

“CommonBond’s refinancing program opens the door for individuals with student loan debt to achieve other financial objectives, such as insurance coverage, home purchase, or retirement savings,” the release said.

The CommonBond program is available on MassMutual’s MapMyFinances financial wellness tool, which helps users prioritize their personal finance and benefits needs based on their family situation and budget. MassMutual introduced a separate student loan repayment and management program last year.

© 2020 RIJ Publishing LLC. All rights reserved.

Brighthouse, Athene announce FIA innovations

Posted on February 6, 2020 by -

Competition and the low interest rate environment continues to drive innovation in the fixed indexed annuity market as companies try to dress up their products and avoid a trend toward commoditization.

A principal driver of FIA sales is the issuer’s ability to tempt clients with the potential for higher returns by offering the highest possible participation rates or caps, which determine how much of the index gain will be credited to the contract owner.

The average cap rate on an FIA account that’s linked to the S&P500 today is only 3.94%, according to Sheryl Moore at Wink Inc., which collects and analyzes data on the annuity markets. FIA issuers are therefore under pressure to modify their crediting methods to make the potential upside look bigger than that.

Index-linked annuity manufacturers all work under similar financial parameters, but there’s room for creativity. In recent years, banks have created exciting-sounding hybrid or custom indices. Some of these indices contain mechanisms or asset allocations that reduce their volatility.

Because these volatility-controlled indices pose less risk of big returns or big losses, the cost of buying options on their performance is less than the cost of buying options on the S&P500 or Russell 2000 indexes. The issuers can thus afford to buy richer options, a tactic that allows them to advertise higher caps or participation rates.

This week there were two new developments on the FIA product front. Brighthouse Financial (formerly MetLife’s retail business) announced the issue of its first FIA. In the past, Brighthouse has issued registered index-linked annuities (its Shield series) but not an FIA. Also this week, Athene added two new custom indices as crediting options on its existing FIAs.

Brighthouse Financial’s first FIA

Brighthouse Financial, Inc. is entering the independent marketing organization (IMO) distribution channel with Brighthouse SecureAdvantage 6-Year Fixed Index Annuity (FIA). The exclusive distributors of the product will be the Market Synergy Group, a large IMO.

The contract allows investors to link to the performance of two widely used indexes, the S&P500 Index or the Russell 2000 Index. They can choose a “point-to-point” crediting method that gives them the net gain, if any, of the index at the end of six years.

Alternately, they can choose an “annual sum” crediting method where the gains or losses of each contract year are added up to produce the total interest credit. Investors who choose this crediting method are guaranteed that they won’t be hit with a record loss greater than 10% in any contract year.

Two new indices for Athene FIAs

Athene USA has added the Nasdaq FC Index, sponsored by Bank of America, and the AI Powered US Equity Index, sponsored by HSBC, to fixed indexed annuities issued by Athene Annuity and Life Company, a subsidiary of Athene.

The Nasdaq FC Index “employs intra-day rebalancing,” an Athene release said. The AI Powered US Equity Index uses IBM Watson and EquBot artificial intelligence to attempt to identify large-cap stocks that are poised for growth.

The Nasdaq Fast Convergence Index is powered by Fast Convergence technology (patent-pending), which allows it to adapt faster to changing market conditions. It applies this high-speed technology to the stocks in the Nasdaq-100, including Apple, Amazon, Google and Netflix. Like the AI Powered US Equity Index, the Nasdaq FC Index uses an internal volatility-control mechanism that allows the issuer to offer higher participation rates.

“By systematically monitoring market moves and rebalancing throughout the trading day, FC technology more efficiently controls the realized volatility of an index with the goal of higher participation rates in fixed indexed annuities,” the Athene release said

The AI Powered US Equity Index, sponsored by HSBC, is “the first and only rules-based equity strategy to use IBM Watson to turn data into investment insight,” the Athene release said. Developed by EquBot, AiPEX continuously monitors the direct and indirect market data that’s created every day to evaluate and score each of the 1,000 largest U.S. publicly traded companies on a monthly basis.

After identifying stocks whose prices are poised for growth, it then uses a three-step equity selection process to rebalance its portfolio monthly. It tries to reduce the impact of short-term volatility in the equity markets through daily re-allocations between the chosen equities and a cash component.

© 2020 RIJ Publishing LLC. All rights reserved.

A New Kind of Old Folks’ Home

Posted on February 6, 2020 by -

Entering retirement as frisky 60-somethings with exotic travel on their minds, most affluent baby boomers don’t think about the decades ahead, when they might not be able to button their own collars, cook their own meals or ambulate without a walker.

But if you’re advising older people on their finances, you know that many of your clients will eventually need a home health aide, assisted living services, or long-term nursing home care. Preparation for such expenses always beats procrastination.

As a fiduciary and a fee-based or fee-only planner, you may also feel obligated to talk to clients about Medicare, supplemental health plans, or the five kinds of Continuing Care Retirement Communities (CCRCs)—even if you don’t bill explicitly for doing so. For the elderly, health care decisions are financial decisions. The costs of treating injury or chronic illness, which may surpass $10,000 a month, can throw a family into turmoil, lead to panicky decisions, and decimate a family’s accumulated wealth if not properly anticipated.

In an occasional series of articles in RIJ, we’ll review the pros and cons of the various solutions to the long-term care dilemma. This week we’ll look at one CCRC, a “fee-for-service” facility where near-retirees can prepare for their long-term housing and medical care needs, instead of waiting until a broken bone or a loss of mental sharpness precipitates a crisis decades from now.

“Ann’s Choice” is a sprawling 1,600-unit apartment, assisted living and nursing home complex in Warminster, a suburb north of Philadelphia. It was built in 2002 on the site of an 18th century farm owned by Quakers Bartholomew Longstreth and his bride, Ann Dawson—the facility’s namesake. The stone houses, fields, woods, and unpaved turnpikes of the colonial era are now a matrix of condominiums, mini-malls and four-lane boulevards.

“Ann’s Choice,” Warminster, PA

“It’s almost like living on a cruise ship,” said Ryan Doherty, a sales counselor who leads tours of Ann’s Choice for prospective tenants, in describing daily life in the 103-acre complex. “People will get up, get dressed and leave their apartments in the morning, and sometimes not come home until the evening.”

On a recent Monday, Doherty was guiding a tour of “Keystone Clubhouse,” one of four multi-use buildings linked by sky-bridges to 17 multi-story apartment buildings. He led the way past administrative offices, a roomful of women learning bridge, a music room, a clubroom with wing chairs, and a large meeting room “where people can fly their drones if they want to,” Doherty said.

Crossing a sky-bridge to one of the residential buildings, Doherty led the way down a carpeted hall where niches of family pictures personalized some of the apartment entrances. By one door were 1970s-era framed photos of a statuesque, auburn-haired woman in the satin bodice and mesh stockings of a men’s club hostess, posing with entertainer Sammy Davis, Jr., and boxer Muhammad Ali.

Like a real estate agent, Doherty showed a visitor the “Fairmont,” the “Hastings” and the “Brighton” sample apartments. All are designed for independent living couples or singles. Each has a kitchen and one or one-and-a-half baths. At 701 square feet, the single bedroom Brighton was the smallest. The other two, at about 1,000 square feet, had two bedrooms. Residents furnish their own units. There are move-in services. Pets are OK; smoking isn’t.

Ann’s Choice residents might remain in the independent living section for the rest of their lives, receiving visits as needed from a housekeeper, health aide, nurse, emergency medical technician or doctor. Many, however, will need help with “activities of daily living” or round-the-clock attention, and will have to move to an assisted living studio apartment or room, to the nursing care area, to the “Memory Care” facility for Alzheimer’s patients, or temporarily to a nearby hospital.

All of the residents have Medicare coverage and a supplemental plan. Ann’s Choice is one of 20 Erickson Living Network of Communities, whose 27,000 residents nationwide must enroll in the Erickson Medicare Advantage HMO unless they have their own Medi-gap policy. Residents who arrive with long-term care insurance coverage are encouraged to keep it.

Paying for it

As a “Type C” CCRC, Ann’s Choice follows a fee-for-service or a la carte expense model. (See box.) It requires an upfront investment in an apartment and a demonstration of enough financial assets to cover future care. Residents who meet the entrance requirements have a near-guarantee of lifelong care.

Ann’s Choice’s costs are geared to match the financial resources of mass-affluent or middle-class couples. Most residents come from the surrounding suburbs and are downsizing from single-family homes. Doherty said many have assets of about $500,000, half of it in home equity and half in invested assets.

“We have tradesmen and we have white-collar people,” he told RIJ. “And the most expensive apartments are located alongside the least expensive apartments.”

The process starts with a $1,000 fee that secures a place on Ann’s Choice’s waiting list. During the waiting period, applicants can access the fitness facilities and restaurants; they want you to get acclimated. Then there’s the purchase of an apartment and a monthly service plan.

The most expensive apartment at Ann’s Choice is a “luxury two-bedroom, two-bath unit with a sunroom/den” for between $476,000 and $636,000. The least expensive is a studio apartment for between $117,000 and $153,000. The ranges indicate differences in locations and features such as balconies, patios or bay windows.

The down payment is 90% refundable to departing residents or their heirs, unless the resident has drawn on its value to pay for services. This is characteristic of Type-C CCRCs, which differ in their treatment of lodging expenses from Type A (irrevocable down payment) and others (partial reimbursement, monthly rental, personal ownership of a purchased unit).

The deposit works a bit like a hybrid fixed annuity with a long-term care rider. That is, the value of the annuity serves as a deductible for the long-term care insurance, and is tapped only if long-term care is needed. If a resident leaves Ann’s Choice, he or she may not get the 90% back immediately, but may have to wait until Ann’s Choice receives fresh funds from a new entrant. That may pose a potential risk factor for residents, but Doherty said Ann’s Choice has a current occupancy rate of 99%. Giving the rising number of retirees in the U.S., filling apartments probably won’t be difficult.

Each style of apartment comes with a corresponding monthly service fee ranging from $2,018 to $3,186 per month. That’s for one person; a spouse or second person costs an additional $897 per month. Monthly fees inflate by 3.5% every year, thus doubling in 20 years, even without an increase in level of care.

The service fee includes the cost of utilities (except telecom), exterior maintenance, and property taxes, along with 30 restaurant meals per month, on-call emergency responders, fitness club membership, and dozens of club activities ranging from bocce to mah jongg to poker to politics.

Incidentals and options like parking spots, visitor meals and lodging, housekeeping and wheelchair rental have separate fees. If a couple goes to Florida for three months in the winter, they get a $36-a-day reduction in their monthly service fee.With 1,600 units, Ann’s Choice is three to five times the size of most CCRCs, so its residents enjoy economies of scale.

Once someone moves to one of the assisted living, skilled nursing, or memory care units in the “continuing care” center, the monthly fees can rise to $6,000 a month or even as high as $14,000 a month, Doherty told RIJ. Again, a Type-A or Type-B CCRC would involve the pre-payment of some or all of those expenses, but a fee-for-service Type-C CCRC like Ann’s Choice doesn’t.

Pros and cons

Doherty said that many people who apply for entrance to Ann’s Choice bring their financial advisers to the meeting. There are no loans involved, but Ann’s Choice wants to know upfront if an applicant’s resources—a combination of investments, long-term care insurance, pensions, Social Security benefits—will be enough to pay whatever expenses arise in the future.

That said, a certain number of beds at Ann’s Choice are reserved for Medicaid patients. According to Doherty, few or no long-term residents are forced to leave for inability to pay; the facility has a “benevolent fund” to help out. Residents are contractually obligated not to give their money away to children or charity after they get in.

The best candidates for a Type-C CCRC like Ann’s Choice will clearly be people who like to plan ahead, who want the ease of condo living, and who like the idea of a bundled solution to their future medical needs. They will have embraced the concept that their home equity will be spent on long-term care or go to heirs, as the situation requires or allows.

Financial advisers should be aware that the management or disposal of the resident’s “outside” assets is subject to a subtle restriction. According to the Ann’s Choice contract, the resident may not “divest yourself of, to sell, or transfer any assets or property interests (excluding expenditures for your normal living expenses) that reduces the assets that you or your representative disclosed as available assets for you on admission, without having first obtained our written consent.”

That doesn’t mean that Ann’s Choice tries to monitor its residents’ finances. “If you were to exhaust your assets and want to spend down the entrance deposit you had put down upon making the move to Ann’s Choice, we would perform an audit to ensure that the money was spent in an honest fashion,” Doherty said.

As an adviser, you would hope that no client of yours would leap into a Type-C CCRC commitment before letting you or an attorney review the contract. But Doherty pointed out that it’s more common for people to wait too long to apply for entrance to Ann’s Choice than to act too hastily.

Members of the Silent Generation (born pre-1946) are apparently famous for balking at the idea of moving to a “home” and losing independence. Many Boomers will undoubtedly feel the same way. “It’s a hard pill for some people to swallow,” Doherty said. But if they wait until they need assisted living services, or if they’ve already spent down too much of their savings, they may not qualify for admission.

As an adviser, the more you know about the financial aspects of downsizing from a family home to a CCRC, the better you can help your clients make this complicated transition efficiently.

© 2020 RIJ Publishing LLC. All rights reserved.