Tuesday, December 29, 2009

Analysis Suggests Participants Don’t Understand Value of Annuities

December 28, 2009 ( – An analysis of retiring participants from one public pension plan suggests they do not understand the value of life annuity payments.

John Chalmers from the Lundquist College of Business, University of Oregon, and Jonathan Reuter from the Carroll School of Management, Boston College, analyzed data on Oregon Public Employees Retirement System (PERS) retirees who must choose between receiving all of their retirement benefits as life annuity payments or receiving lower life annuity payments coupled with a partial lump sum payout… [Looking] at variation in the value of the incremental life annuity payments arising from how PERS calculates retirement benefits, the researchers found evidence that demand for lump sum payouts is higher when the forgone life annuity payments are more valuable. 
Chalmers and Reuter also found that demand for lump sum payouts is higher when the lump sum payout is "large," and when equity market returns over the prior 12 months are higher.
"Collectively, these findings suggest that retirees value incremental life annuity payments at less than their expected present value, either because they do not know how to accurately value life annuities or because they have strong demand for large lump sum payouts," the researchers wrote in a working paper for the National Bureau of Economic Research (NBER).
The researchers did find that those with poor health at retirement more consistently utilized "value-maximizing decision-making."
According to the NBER working paper, the Oregon PERS data showed that the higher the money’s worth of the incremental life annuity payments, the more likely the retiree is to choose the partial lump sum option over the full life annuity option. "This (robust) finding suggests that retirees facing more valuable incremental life annuity payments either attach greater value to the lump sum payout or … underestimate the value of the incremental life annuity payments," the researchers wrote. …
The research findings suggest that the fraction of retirees demanding a lump sum is associated with the returns on the prior 12-month returns to the S&P 500 index. …

The researchers also found that demand for the partial lump sum option is lower for retirees earning high salaries, and speculate that this is because these retirees are less financially constrained or more financially literate.
Rebecca Moore

Monday, December 28, 2009

Clock Ticks On Estate Tax

Financial Advisor Magazine
(Dow Jones) As Congress appears ready to let the federal estate tax lapse on January 1, a dramatic question is what a repeal will do to millions of less affluent taxpayers.
Many who now would owe neither estate nor capital gains tax on inherited assets will owe significant capital gains. And that's just one of the troubling aspects of a repeal.
There are also serious questions about how families with ailing relatives would be affected--a subject of gallows humor since a one-year repeal of the tax was first envisioned for 2010 years ago. …
Under current law, the estate tax disappears for a year in 2010 and then is reinstated in 2011…
For many advisors, the most striking aspect of a repeal is that, along with the estate tax itself, a step-up in cost basis for income tax purposes would go away. …
So, at a relative's death, "families that would not have had to pay the estate or capital gains tax now may have to pay a capital gains tax on assets that have appreciated in value during the deceased person's lifetime," said Warren Racusin, chair of the trusts and estates practice at law firm Lowenstein Sandler in Roseland, N.J.
Racusin mentioned a client whose parents gave him Microsoft Corp. stock when he was younger, purchased for relatively little, that is now worth $6 million. If the man were to die in 2009, his family would not owe capital gains tax on the appreciation. And, with good estate planning by the man and his wife, there might be no estate tax due either, because a couple can shelter up to $7 million from federal estate tax.
If the man were to die on January 1, 2010, however, his wife could owe capital gains of around $340,000 on the $6 million, figuring in a $3 million exemption for spouses, and another $1.3 million exemption for whoever inherits.
As for a retroactive tax, it would likely raise some complications if lawmakers wait too long to enact it. Relatives of some people who die in a prospective estate-tax-free period--after the end of the year but before a new tax is enacted--would surely not be pleased. Quite certainly, some would challenge the constitutionality of the tax, according to tax analysts.
Nonetheless, both the lower courts and the Supreme Court historically have defended retroactive taxes. …
Copyright (c) 2009, Dow Jones. For more information about Dow Jones' services for advisors, please click here.

Monday, December 21, 2009

Affluent households ignore 529 plans, study says

Investment News

Despite tax breaks, report says the market is under-penetrated

By Charles Paikert
June 14, 2009, 6:01 AM EST
Two-thirds of affluent parents with children under 18 aren't using Section 529 college savings plans, according to a report by The Phoenix Cos. Inc. …
“I was really surprised at the extent to which the high-net-worth segment is not using 529 plans,” said Walter Zultowski, senior vice president of research and concept development for Hartford, Conn.-based Phoenix and author of the report. “529s should be a no-brainer for them.” …
Jeff Coghan:
Jeff Coghan: "We are still early in the life cycle of this product."
“I would think that 529s would be part of financial planning for affluent parents, especially with the tax benefits,” said JoLynn Free, senior vice president and financial consultant in Austin, Texas, for RBC Wealth Management of Minneapolis. “We certainly recommend them, and as a vehicle, I've found them to be solid gold.” …
In addition to the tax benefits of 529 plans, Ms. Free said that affluent clients like the fact that parents, not children, remain owners of the account. What's more, 529 accounts appeal to high-net-worth parents and grandparents because they can easily transfer cash into a tax-protected account, she added. …
E-mail Charles Paikert at

Social Networking And Advisors

Financial Advisor Magazine
Advisors are barely scratching the surface in their use of social networking.
By Andrew Gluck
Of all the social networking Web sites, LinkedIn is the one financial advisors use most. …
Not a lot of reliable data are available yet on the business use of social networking applications. We don’t have much demographic data about who is on each social network or the business benefits of tweeting on Twitter versus connecting on LinkedIn or friending on Facebook. But here are some thoughts that might be valuable as you decide which sites to use for growing your advisory firm and exchanging ideas with other professionals.
They’re Not Just for Kids. According to a study released by Anderson Analytics, SPSS and LinkedIn, the number of C-level executives on LinkedIn numbered 2.2 million worldwide last summer, while there were 1.9 million executive vice presidents and senior vice presidents on the network. Some 4.5 million users said they were senior management, while 5.2 million said they were middle management. About half of the users worldwide are in the U.S., and the base was growing last year at a rate of 2 million a month.
By contrast, Twitter users are overwhelmingly young, according to a study by Pew Research Center released in February. However, … Twitter is not dominated by the youngest of young adults. Indeed, the median age of a Twitter user is 31. In comparison, the median age of a MySpace user is 27, while it’s 26 for a Facebook user and 40.5 for a LinkedIn user, according to the Pew study.
… In the U.S., users between the ages of 55 and 64 made up 10% of Twitter’s total, which is nearly the same figure for those users between ages 18 and 24, who accounted for 10.6%. So you are seeing older Americans adopt social networking at an astounding rate.
Say Something Nice. Unlike traditional marketing, social networking is totally based on being nice to other people and not just selling your services. The key to successful marketing is giving valuable information to your target market. For instance, an advisor trying to market to doctors might post a blog offering a case study of changes he made to a doctor’s financial plan after the market meltdown of last year, and then tweet about that. … Another nice thing to do is establish a group on LinkedIn for doctors in a particular geographic area in need of financial and business management advice. …
Target, Target, Target. Just as the old adage emphasizes “location” as crucial to real estate values, it’s also crucial to target your marketing when you’re social networking. The more focused you are, the more likely you are to find an underserved niche that needs you and the less likely you are to encounter competitors. …  I recently gave a Webinar in which I explained how to automatically tweet your Google alerts. It makes sense to tweet such information because Twitter is good for distributing news. LinkedIn, meanwhile, is better for networking and creating groups.
Find Prospects. Both LinkedIn and Twitter are good ways to find prospects, and though one fishing strategy is not very nice, you should know about it anyway—and that’s looking into your competitors’ networks. While LinkedIn lets you hide your own network from the public and Twitter lets you block people you don’t know from receiving your tweets, the public (and competitors) can still see who is in your network even when you make your updates to Twitter private. So you may want to avoid connecting with clients on Twitter and only use it for prospecting.
To find prospects on LinkedIn, you can search its vast database, clicking “search,” and then narrowing that search on the pull-down menu to “search companies.” …
To find prospects on Twitter, you can search site profiles using some of the new Twitter search engines popping up, including: Tweepsearch, Twellow, Twubble and Mr. Tweet. Also check out a promising new registry for business-to-business searches on Twitter called Twibs. …
Compliance. Regulators offer little guidance about how advisors can use the new tools of social networking, apart from referencing existing advertising rules. …
To be sure, existing regulations are clear on many aspects of social networking. Still, it could save broker-dealers and RIAs a lot of money if the SEC and FINRA would offer more guidance, because then technology systems could be built to accommodate the rules. …
In the meantime, registered reps are clearly at a disadvantage, since some B/Ds are simply banning the use of certain social networking sites. Many have forbidden the use of Twitter or blog-writing by their reps.

Look Before Rolling Over a Business Startup
(December 15, 2009)
By William Brighenti

Promoters have been marketing on the Internet the use of 401(k) funds to purchase franchises or startup businesses, which normally require up-front material sums of monies to launch.

The procedure typically involves the creation of a C Corporation by the business owner, then the setup of a retirement plan for its employees, followed by the rollover of the new business owner-employee's 401(k) funds into this new plan, and ultimately the exchange of corporate stock for the funds in the plan.

Logo of Internal Revenue Service, USA
Logo of Internal Revenue Service, USA (Photo credit: Wikipedia)
Hence, the acronym ROBS: roll-overs as business startups. … A recent memo issued by the Internal Revenue Service characterized the rollover for a business startup as a "scheme" in the marketplace to access retirement funds to evade income taxes and the withdrawal penalty of 10 percent on their premature distribution. …

If your clients are already sold on this procedure and nevertheless wish to pursue it, here are a few recommendations that may help them:

1.    Hire an appropriate attorney to prepare the new retirement plan document. Avoid using the M&P (master and prototype) plan provided by the franchise seller. A number of promoters of ROBS transactions are on the IRS's watch list.
2.    Have an objective valuation of the stock of the new corporation prepared with supporting detailed analysis. … The lack of a bona fide appraisal would raise a question as to whether the entire exchange is a prohibited transaction.
3.    Before purchasing a franchise through promoters charging fees out of the proceeds of the stock purchase, consider whether they can be construed by ERISA or the IRS as "fiduciaries" rendering "investment advice" or administering the plan. If a fiduciary receives a payment from the plan assets, it may constitute a violation of the Tax Code.
4.    Enable future employees to acquire employer stock. … In order for the plan to not discriminate in favor of highly compensated employees, an extension of the stock investment option must be afforded to non-highly compensated employees to be hired in the future.
5.    Establish the plan as permanent; do not discontinue it within a few years after its adoption.
6.    Never pay purely non-business expenses from the plan.
7.    Communicate in writing the existence and availability of the plan to all new employees; otherwise, your plan will be in violation of Treasury regulations and may result in its failure.

Pension (Photo credit: Frederik Seidelin)
The consequences of entering into any prohibited transactions and of carelessly setting up a ROBS are staggering penalties of 110 percent or more of the amounts involved in the transactions or the roll over itself. On Nov. 5, 2008, the IRS issued the following warning to all business owners contemplating the implementation of a ROBS arrangement:
“For these reasons, we intend to scrutinize ROBS arrangements. … We believe that ROBS arrangements may endanger the qualified status of otherwise tax-qualified employee plans and may be prohibited transactions, requiring complete undoing of the transaction, and imposition of excise taxes.”

So tread carefully, and your clients should obtain the necessary legal, accounting and other professional advice before adopting a ROBS arrangement. Or perhaps they should even consider other alternatives, such as borrowing from their 401(k) plan.

William Brighenti, CPA, is a Certified Valuation Analyst and Certified QuickBooks ProAdvisor, who operates Accountants CPA Hartford in Hartford, Conn. He writes the blog Accounting and Taxes Simplified.
Enhanced by Zemanta

Monday, December 14, 2009

Stop Giving Your Customers Too Many Choices — They Don’t Want Them!

The Accidental Product Manager
December 9, 2009
Image Credit Too Many Choices Can Make Your Customers Decide Not To Buy
Too Many Choices Can Make Your Customers Decide Not To Buy
As product managers, we have somehow convinced ourselves that our customers both want and need more choices when it comes to our products. … However, it just may be the case that the one thing that our customers really don’t want is to have to make more decisions in order to buy our products.
Product managers at one company seem to have figured this out and they are using this knowledge to kick Netflix’s butt…

The Story Of The redbox

…There are more than 18,000 redbox kiosks out there right now. You’ve probably seen them because they seem to be everywhere: drugstores, grocery stores, and even in some McDonald’s restaurants. The company says that they are installing new kiosks at a rate of about one per hour….

The Secret Of redbox’s Success

If you’ve ever seen a redbox kiosk, you probably quickly realized that it has a pretty poor selection of DVDs that you can rent. … Each kiosk offers only 125-200 different titles — that’s a far cry from either a Blockbuster store or Netflix’s online catalog. And yet, it sure seems to be succeeding. What’s up with this?
What the redbox product managers have found is that consumers are being overwhelmed with so many choices that often we just simply choose to not buy anything at all. Limiting the number of choices that we have to make appears to be a big part of the appeal of the redbox product.
In the early days, the redbox product managers experimented with loading the kiosks up with a wide variety of different titles including classic and foreign films. What they found out from these experiments was that their customers really didn’t want more choices. What they wanted was some help and guidance on what they would enjoy watching.

Keeping It Simple

Due to where their kiosks are located, redbox doesn’t really want their customers to take too much time browsing: make a quick decision and then move on. …
What redbox has done is to realize that new releases is what is going to draw in most of their customers. … This means is that they may be losing some customers who are looking for some of the “long tail” movies that are not so popular. So what: redbox seems to be doing quite well even without them.

What All Of This Means For You

Taking a step back and looking at what redbox has accomplished, we need to realize that there is a message here for all product managers. …
Life today is complicated for everyone including our customers. We like to add options to our products so that we can appeal to even more potential customers. Maybe what we should be doing instead, is simplifying how our products appear to our core base of potential customers and making it easier for them to buy our product.
This would require you to go back and look at all of the different variations of your product that you are currently offering. … If you dropped the low performers, would you make your product more attractive to potential customers because it was less complex? This is a lesson that we all need to learn before our competition does…
Do you think that customers would buy more of your product if you offered them fewer options?

Plan Sponsors May Face New Fiduciary Responsibilities


Plan sponsors need to increase their educational efforts and may find it prudent to engage an outside investment advisory firm as well as competent legal counsel so as to assume and delegate fiduciary responsibility for the advice provided on behalf of the plan, as well as plan participants and beneficiaries, ensuring that suitable guidance is provided with respect to guidelines pursuant to ERISA law.

GLG News
December 7, 2009


Plan sponsors need to increase their educational efforts and may find it prudent to engage an outside investment advisory firm as well as competent legal counsel so as to assume and delegate fiduciary responsibility for the advice provided on behalf of the plan, as well as plan  participants and beneficiaries, ensuring that suitable guidance is provided with respect to guidelines pursuant to ERISA law. 


…As a result of the Pension Protection Act of 2006, conditions were developed in order to provide professionals the ability to provide specific investment advice rather than solely investment education. The PPA later requested that the DOL provide further clarification and more detail as to what would be considered permissible concerning advice rendered.  … Effective November 19, 2009 the U.S. Department of Labor announced the publication of notice withdrawing the final rule on the provision of investment advice  …
In general, the reason for withdrawing the final rule stems from issues concerning possible conflicts of interests with certain service providers and as to whether the associated exemptions proposed in the rule would adequately protect the interests of plan participants and their beneficiaries. …
From the standpoint of pension service offerings, most employers or Plan Sponsors to a pension plan are deemed to have fiduciary responsibility. … An employer or Plan Sponsor is considered a fiduciary with respect to an employee pension plan if the employer is named as a fiduciary in the plan, or if the employer exercises any discretionary authority over assets or with respect to the administration of the plan.
… Most importantly, Plan Sponsors have a duty to inform, providing participants with sufficient information to make investment decisions; furnish relevant data concerning benefits and plan provisions; and notify participants with respect to amendments to the plan.
…   ERISA also imposes fiduciary obligations on anyone who promulgates or renders investment advisory service for compensation, or those having the authority or responsibility to render such advice, with respect to any pension plan money or property. ERISA maintains enforcement procedures that may be initiated in some circumstances, by participants, beneficiaries, as well as the U.S. Department of Labor for negligence on the part of fiduciaries or any service providers to the plan.
Necessary steps should be taken by all Plan Sponsors to establish guidelines for investment policy, participant education, and legal compliance. Although ERISA expressly permits trustees and other fiduciaries to appoint investment managers, as part of their fiduciary responsibility, Plan Sponsors should ensure that pension plan operations are monitored. It is also critical to establish procedures that clearly indicate that fiduciary responsibilities are being satisfied. Plan fees should also be reviewed to ensure compliance with sponsor prudence.
While 404(c) regulations do not specifically require participant education, Plan Sponsors should make reasonable attempts to provide general investment education, particularly since the U.S. Department of Labor provides guidance on how to provide investment education without creating fiduciary liability for investment advice.  …  Additionally, the new regulations are likely to increase the responsibilities of retirement Plan Sponsors as a whole.
Employers and Plan Sponsors should avoid providing individualized advice or assistance to plan participants and beneficiaries with regard to the selection of investment vehicles. Furthermore, if an employer or Plan Sponsor has not retained a registered investment advisor, a disclaimer should be provided in all related materials stating that the information is not intended to be specific investment advice and those participants are urged to seek advice from their own investment professional.
By actively managing the risks associated with participant directed plans through activities that include, but are not limited to; conducting annual fiduciary reviews; adopting written procedures concerning investment policies; and providing information through investment education, Plan Sponsors may be able to reduce their liability exposure and facilitate the process of managing their fiduciary responsibility.
Given the current status of the regulations with respect to advisory guidance provided to participants of tax qualified retirement accounts, Plan Sponsors need to prepare for additional investment rules that could potentially arise regarding defined contribution plans. It may also be prudent for Plan sponsors to … wait to see what the new requirements will be before safely assuming who may provide such investment advice to plan participants.
End Notes
Department of Labor Field Assistance Bulletin,
Employee Benefits Security Administration News
None of the information or content contained herein is intended to create an investment advisory client relationship between the reader and the author. The information contained within this article is not be construed as personalized investment advice or a substitute for investment advice. Investments or strategies mentioned in this article may not be suitable for all individuals. All readers of this article should make their own individual decisions. The material contained within this article, does not take into account each reader’s particular investment objectives, financial circumstances, or needs. All readers should strongly consider seeking advice from their own investment advisor, tax practitioner, or legal counsel.

The four stages of an annual review

A top-down approach to assembling, analyzing and acting on portfolio data is advisable
Investment News
By Blaine F. Aikin
December 6, 2009
As the year draws to a close, fiduciaries should be turning their attention to one of their most important responsibilities: the annual portfolio review. This is a prime event conducted in the process of fulfilling the continuing fiduciary duty to monitor. It is the time when the fiduciary undertakes a comprehensive assessment of whether the investment objectives of the investors they serve are being met.
Monitoring involves four stages: gathering material information, analyzing the implications of the information, acting appropriately on the findings of the analysis and documenting the basis for actions considered and actions taken. Effective monitoring hinges on deciding at the outset what information is relevant to determining whether the current portfolio management process is meeting investor objectives and is likely to continue to do so. A top-down approach is generally recommended to assemble, analyze and act upon this information.
Start by addressing what has changed at a level above portfolio composition and holdings. Most importantly, consider whether the investor's objectives have changed, in which case there is a direct effect on what information is material, as well as on the decisions that will bring the portfolio management process into alignment with the new objectives.
Change in laws or regulations, the economy and the financial markets is also relevant to most portfolios. For example, 22 states this year introduced or enacted the Uniform Prudent Management of Institutional Funds Act. This should be a major discussion topic in the annual portfolio review process of most endowments and foundations in those states.
Similarly, the implications of historically high unemployment, unprecedented government stimulus spending and extraordinary market volatility have profound implications for domestic investments. While no one can say with certainty the precise nature and magnitude of these implications, the annual review process should demonstrate thoughtful deliberations of these matters and how they influenced investment decisions.
Next, examine portfolio composition and asset allocation issues. Performance of the broad asset classes over the past year and longer time periods is generally the focus of attention, but unusual volatility within certain asset classes and apparent changes in the correlation among asset classes are important factors for analysis. Even if certain asset classes are not represented in the investment portfolio being reviewed, it is advisable to consider a wide range of accessible asset classes for potential introduction to the portfolio.
Simply by improving the asset allocation of the portfolio, it may be possible to achieve higher-than-expected returns for the level of risk the investors are prepared to take. To make this determination, Monte Carlo simulation, mean-variance or re-sampled efficiency optimization, or a comparable analytical tool may be applied. Model portfolios supported by sound research and analysis may serve as the basis for decision making.
For participant-directed plans, changes in the available asset classes may be warranted, based upon findings from this stage of review.
If tactical asset allocation (a form of market timing) is employed in managing the portfolio, the value added by asset allocation moves should be carefully analyzed at this stage. The value of this approach can be assessed by comparing the results of tactical decisions against what would have been achieved by using a strategic benchmark allocation.
Finally, revisit the due-diligence criteria used to select the specific investments held in the portfolio and evaluate each position for shortfalls that may have developed. With respect to performance, each portfolio holding should be compared with an appropriate index and peer group benchmark. While manager performance is often the focus of attention during quarterly portfolio reviews, the annual review should be more comprehensive and balanced. In rough order of priority, an effective annual review process should result in sound decisions with respect to: current investor objectives and investment policy provisions, investment philosophy and strategy, asset allocation, re-balancing activities, and investment manager watch listing and replacement.
The annual review will be incomplete until the deliberations and decisions of the process have been recorded. These records help ensure that planned actions are taken and subsequent moves planned with the benefit of information previously considered, and demonstrate that a prudent process has been followed. That is especially important at a time such as the present, when an extraordinary investment environment lends itself to rampant second-guessing.
Blaine F. Aikin is chief executive of Fiduciary360 LLC.

Required Minimum Distribution Rules Change After This Year
NEW YORK, NY, December 7, 2009 -- "The 2008 tax legislation to give senior citizens a reprieve from the requirement to take 2009 required minimum distributions (RMDs) from employer-sponsored tax-qualified retirement plans and IRAs was a relief to many," says Lesli Laffie, tax analyst for the Tax & Accounting business of Thomson Reuters. "… However, there may be sound tax reasons to either take or stop taking RMDs before 2009 ends," she advises. "And, seniors who are well-off and charitably inclined may want to consider transferring up to $100,000 of IRA funds directly to charity before 2010."
The RMD Quandary
… In years other than 2009, the failure to take an RMD could trigger a 50 percent penalty on the undistributed RMD. The 2009 RMD 'holiday' is available to taxpayers who own or are beneficiaries of retirement plan accounts (generally, 401k, 403(b), or 457(b) plans), or who are traditional IRA owners or beneficiaries, or Roth IRA beneficiaries. The holiday means they can withdraw less than 100 percent of their RMDs for 2009, without incurring the penalty. The suspension without penalty applies only to RMDs otherwise required for 2009, not to RMDs for 2008 that had to be taken by April 1, 2009. Taxpayers who turned 70 1/2 in 2009 still must take an RMD by Dec. 31, 2010.
"There are a number of issues to bear in mind when deciding whether or not to withdraw in 2009," says Laffie. "For those who have inherited Roth IRAs, withdrawals are tax free, so the only decision for those beneficiaries is whether to leave or withdraw account assets."
Consider taking RMDs before 2009 ends if:
  • Your tax rate may be lower in 2009 than in 2010. … Rates are always subject to change, "but if a taxpayer believes he will be in a higher tax bracket in 2010 (due to higher income and/or fewer deductions), he may want to take RMDs in 2009 to incur tax at the lower rate," advises Laffie. In addition, a 2009 RMD would lessen the amount of future RMDs. "If a taxpayer anticipates that tax rates will go up in the future, acceleration of RMDs into 2009 may be an appropriate strategy."
  • You have offsetting deductions. Taxpayers with high 2009 deductions relative to income, such as medical expenses, may be able to offset an RMD, but will lose the part of the medical deduction that equals 7.5 percent of their adjusted gross income (AGI). A taxpayer with a charitable contribution deduction carryover that will expire soon, or with a net operating loss, may also be able to offset the increase in income from an RMD.
  • You receive social security. A taxpayer whose Modified AGI (MAGI) is below the level requiring taxability of social security payments should consider taking an RMD to the extent those payments will continue to escape taxation…
  • You decide to roll over the distribution into a Roth IRA. Because RMDs are not required for 2009, a 2009 withdrawal is not considered to be an RMD. Therefore, it can be rolled over into a Roth IRA (as long as MAGI does not exceed $100,000 or you are not married filing separately). …"In 2010, more lenient rules take effect in rolling over a traditional IRA to a Roth IRA, but they won't apply to RMDs," notes Laffie.
Consider taking the RMD holiday (i.e., suspending RMDs) for 2009 if:
  • More of your social security payments will become taxable. Taxpayers receiving social security, but whose payments have not yet triggered 85 percent taxability (joint filers with MAGI under $44,000, or under $34,000 for singles and HOHs), should consider forgoing RMDs. …
  • Your income is high. If taking an RMD would subject you to a phaseout of itemized deductions and/or personal exemptions, it is probably beneficial to skip the RMD.
  • You have other sources of income to pay bills, and therefore do not need the RMD. …
"Skipping or taking the RMD holiday, or taking only partial RMDs, is an individual decision requiring analysis of various factors," advises Laffie. "Before 2009 ends, taxpayers should take a look at their overall tax picture and make the decision that's optimal for them."
Donating IRA Funds to Charity
Until the end of 2009, those age 70 1/2 and older can contribute up to $100,000 from their IRAs directly to one or more charities. This transfer is not included as income on the federal tax return. But you do not get a charitable deduction, and the withdrawal does not count as an RMD because RMDs are not required for 2009.
So why consider such a donation now? "For those who are very charitably inclined, the technique may hold appeal, in part because these donors won't reach the ceiling on charitable deductions," observes Laffie. "Also, by using IRA money to make the donation, a taxpayer retains more of his other savings for his own use. In addition, because the amount transferred isn't included as income on the federal return, it won't trigger deduction and/or exemption phaseouts. Finally, it may be a good strategy for people who don't itemize, because they are not losing out on a charitable deduction."
"While the RMD holiday and the ability to transfer IRA funds directly to charities end when 2009 ends, it's possible one or both of these tax breaks could be extended into 2010 or beyond," says Laffie.
About Thomson Reuters
Thomson Reuters is the world's leading source of intelligent information for businesses and professionals. We combine industry expertise with innovative technology to deliver critical information to leading decision makers in the financial, legal, tax and accounting, healthcare and science and media markets, powered by the world's most trusted news organization. With headquarters in New York and major operations in London and Eagan, Minnesota, Thomson Reuters employs more than 50,000 people and operates in over 100 countries. Thomson Reuters shares are listed on the Toronto Stock Exchange (TSX: TRI) and New York Stock Exchange ( TRI). For more information, go to

Monday, December 7, 2009

The Plan Sponsor’s Ability to Evaluate Conflicts of Interest

Reish & Reicher
When making decisions about their retirement plans, plan sponsors have a duty to understand and evaluate conflicts of interest that could impact the plan. In some cases, plan sponsors are prohibited from entering into transactions that involve conflicts of interest.
Those conflicts fall into two broad categories. The first is where the plan sponsor has a conflict. The second is where a service provider has a conflict of interest.
On the former, a plan sponsor must put the interest of the participants ahead of its own when making decisions about retirement plans. For example, if a bank told a plan sponsor that it would get a lower interest rate on its corporate loans, or a larger extension of credit if the administration of the plan was placed with the bank, the plan sponsor would have a conflict in making that decision. That is because, from a corporate perspective, it would be in the plan sponsor’s benefit to get the better loan. However, from a retirement plan perspective, it may or may not be in the best interest of the participants. But, in this case, the plan sponsor cannot avoid the conflict simply based on the quality of the bank’s 401(k) services. That is because ERISA strictly prohibits the plan sponsor from gaining any advantage from its use of plan assets. Even if the arrangement is favorable to the employees, it is strictly prohibited by ERISA.
Some conflicts are not prohibited by law, but even then, a plan sponsor must evaluate the conflict and act in the best interest of the participants. …
The balance of this article is about the second type of conflicts – those involving service providers.
So that you fully appreciate the legal responsibility, let’s look at what the DOL says:
With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. The process also must avoid self dealing, conflicts of interest or other improper influence.
That is a difficult job because, while the provider knows about its conflicts, a plan sponsor may not. So, the starting point is for the plan sponsor to ask the provider to describe, in writing, all materials conflicts of interest that could impact the plan and/or the participants. …
What are material conflicts of interest? Typically, but not always, a material conflict involves money. For example, is your adviser receiving money from one of the providers or from the investments? If so, that creates a conflict where the adviser may favor the provider or the investment over the plan and the participants. It doesn’t mean that the adviser will make biased decisions (and, in our experience, most do not), but it does mean that there is the potential for a biased decision. …
…[If] your provider refuses to give you the information (but you want to continue to work with that provider), you have a fiduciary duty to investigate in order to determine whether there are any conflicts. Among other things, that means that you need to carefully read all of the materials that the provider gives you—and you should probably have your ERISA attorney review those materials and advise you on potential conflicts as well. …

Any U.S. federal income tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.

© 2009 Reish & Reicher, A Professional Corporation. All rights reserved. The REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish & Reicher does not warrant and is not responsible for errors or omissions in the content of this report.

The Different Flavors of ERISA Fiduciaries

Morningstar Advisor
by W. Scott Simon  | 12-03-09
…The significance of the added protection afforded a plan sponsor when it utilizes the services of an advisor serving as a fiduciary under section 3(38) of the Employee Retirement Income Security Act of 1974 as opposed to an advisor serving as an ERISA section 3(21) fiduciary
ERISA Selection, Monitoring, and Replacing Functions
…A critical duty is the sponsor's legal responsibility (and therefore legal liability) to select, monitor, and (if necessary) replace the plan's investment options. This duty is so central to any ERISA-qualified retirement plan that its breach is often pleaded in the recent cases filed against plan sponsors involving plan investment options bearing costs that are not reasonable. … The appropriate fiduciary of a plan must (affirmatively) find costs to be reasonable in order to justify their expenditure for the corresponding services rendered. …

An ERISA Section 3(38) Fiduciary
ERISA provides that a plan sponsor can delegate the significant responsibility (and therefore significant liability) of the selection/monitoring/replacing functions to an ERISA section 3(38)-defined "investment manager" who, upon delegation, then becomes an ERISA section 405(d)(1)-defined "independent fiduciary." An ERISA section 3(38) fiduciary can only be (a) a bank, (b) an insurance company or (c) a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940. This means that a stand-alone broker-dealer, for example, cannot be an ERISA section 3(38) fiduciary. …

An ERISA 3(38) fiduciary has ERISA legally defined "discretion" that makes it a decision-maker. This means that a 3(38) fiduciary actually makes decisions for which it is legally culpable (and for which the plan sponsor is no longer legally culpable). An ERISA 3(38) fiduciary decides what investment options such as stand-alone mutual funds or model portfolios should be placed on a plan's menu, whether to remove them from the menu and, if it does remove them, what investment options will replace them. …

An ERISA Section 3(21) Fiduciary
In sharp contrast to the legally culpable, discretionary decisions made by an ERISA section 3(38) fiduciary are the legally blameless, nondiscretionary recommendations made by an ERISA section 3(21) fiduciary. To the extent that an advisor is even named as any kind of fiduciary in an investment management agreement between a plan sponsor and an advisor, in most cases the advisor is an ERISA 3(21) fiduciary tasked with "recommending," "assisting," "helping," or "advising" the sponsor as the sponsor itself goes about making selection/monitoring/replacement decisions.

Such contracts make clear that an advisor who is a 3(21) has no legally defined "discretion" to actually make decisions about plan investment options but only to be a helpful gnome to the plan sponsor who continues to retain the significant responsibility (and therefore the significant liability) to select, monitor and (if necessary) replace plan investment options. …

In many agreements, of course, the advisor is not even named as a fiduciary and its roles are simply described as "assisting," the plan sponsor in making investment option selections (for which the sponsor is legally responsible and liable).

Summing UpIn a nutshell, here is the difference between ERISA section 3(38) fiduciaries and ERISA section 3(21) fiduciaries:
* An ERISA section 3(38) fiduciary must make decisions for which it has legal responsibility (and therefore legal liability), because such a fiduciary is charged with ERISA-defined "discretion." … This gives a plan sponsor significant cover from fiduciary risk.
* An ERISA section 3(21) fiduciary makes only recommendations for which it has no legal responsibility (and therefore no legal liability), because such a fiduciary has no ERISA-defined "discretion." This does not give plan sponsors cover from fiduciary risk.
An Important Caveat
It's important to understand that the part of the preceding discussion referring to an ERISA section 3(21) fiduciary concerns what can be described as a "limited scope" 3(21). …
Distinct from a limited-scope 3(21) fiduciary (the kind which is almost always discussed in the investment media) is what can be described as a "full scope" ERISA section 3(21) fiduciary. The full scope 3(21) is the "named fiduciary" of a plan; that is, the person who has ultimate authority over a plan. All qualified retirement plans governed by ERISA have a named fiduciary, and that person is always a 3(21) fiduciary, representing the plan sponsor. The plan sponsor, as the originating full scope 3(21) fiduciary of the plan, can delegate all the duties associated with same to an entity that will assume them. …

Friday, December 4, 2009

Will the DB(k) Plan Replace the 401k?

eRollover Blog
 By Mike Rowan, 11/18/2009

Meet the DB(k) Retirement Plan

… One retirement plan that will become available in 2010 offers a 401k alongside a guaranteed pension-like retirement benefit.
This new plan is called the DB(k) and it has its beginning in tax code from 2006. The tax law allows companies with fewer than 500 workers to start the DB(k) after Jan. 1, 2010, and many advocates would like to see it available to everyone. …

Questions and answers about details of the new DB(k) Plan:

Q: What are the features of the DB(k) Plan?

A: There are two parts to the new plan:
Employers will be required to establish a pension fund sufficient to pay  up to 20 percent of that individual’s average annual salary received during the last few years in the workforce. Once the employee has spent three years with a company, their benefits will become fully vested.
… The balance in this retirement account would be paid at retirement like a traditional type of pension plan. …
At the same time, the employer will be required to take 4 percent of a worker’s salary and put it in a 401k plan. The company must match at least 50 percent of the contribution, and would be immediately vested. Upon reaching retirement, the worker could withdraw additional funds from their 401k account as needed.
Employees can opt out of their contribution or they could chose to set aside less.
Q: Why create a hybrid type of pension/401k plan?
A: More companies are dropping traditional pension plans and employees with a 401k often do not save enough, leaving workers woefully unprepared financially for retirement.
The concept behind the DB(k) allows employers to provide the benefits of a combined plan without the paperwork, regulatory requirements, and elevated costs that would come with operating a pension and 401k plan separately. As a result, in theory employees get a more secure retirement with a guaranteed pension alongside their own 401k savings.
Q: What types of companies would be a good fit for a DB(k) and why?
A: Companies must have at least two and no more than 500 workers to implement a DB(k) plan. It is anticipated that DB(k) retirement plans will be offered by companies looking for professional workers in competitive fields. The Employer completely funds the pension and provides matching contributions in the 401k plan
Q: When will we start seeing DB(k) plans in the marketplace?
A: The DB(k) plan is authorized by the Pension Protection Act of 2006, which gives permission for companies to begin offering the plans starting on Jan. 1 of 2010. However, the IRS and the U.S. Treasury Department only recently began developing rules for the DB(k), so it may be delayed until later in the year. …

Friday, November 20, 2009

The Roth of Con(versions)

Tax Increase Protection and Reconciliation Act of 2005 (TIPRA)

TIPRA has a forward-looking provision regarding Roth conversions. It repealed the MAGI limit of $100,000 for 2010 and beyond on conversions. The contribution limits remain intact.
TIPRA also provided for a special tax treatment of Roth Conversions made in 2010. Unless a taxpayer elects otherwise, income from the conversion is taxed over a two-year period, beginning in 2011. So, if a taxpayer converts $100,000 of Traditional IRA money to a Roth IRA in 2010, he will add $50,000 to his tax return for the 2011 tax year, and $50,000 to his tax return for the 2012 tax year. If the taxpayer elects, he may add the entire $100,000 to his tax return for the 2010 tax year.

Cents and Sensibilities

The feasibility of a Roth Conversion depends on tax rates at the time of conversion, tax rates at the time of distribution, availability of funds to pay the taxes, expectations of portfolio growth, and likelihood of passing the account to non-spouse beneficiaries. Many of these factors are unknown; a decision needs to be made based on reasonable expectations. By evaluating the following questions, a Traditional IRA owner can to determine what the practical approach is:
  1. Will tax brackets rise after 2010?
  2. Will tax brackets remain above current rates for an extended period of time?
  3. Do you expect the account balance to increase meaningfully during 2010?
  4. Do you have non-retirement funds that you can use to pay the tax liability upon conversion?
  5. Will the Roth IRA likely survive both you and your spouse?; also,
  6. Will Congress initiate new taxes in 2010 that will be retroactive?
  7. Will a conversion trigger Alternative Minimum Tax or other surtaxes, or will it accelerate the phase-out of deductions and exemptions?
The more confident the taxpayer is that the answers to questions 1-5 are "Yes" and the answers to questions 6 and 7 are "No," the more confident he can be that a conversion early in 2010 would be practicable. The taxpayer should also consult his tax advisor before committing to any conversion.

To Bifurcate or Not To Bifurcate, That Is the Question

Assuming we convert to a Roth IRA in 2010, we have a choice of when to pay taxes. For conversions that occur in 2010 only, the taxpayer may pay the tax liability by April 15th, 2011, or they can add one-half of the converted amount to the tax return they file by April 15th, 2012 and the other half on the tax return they file by April 15th, 2013.
At first blush, you would think that we want to defer taxes until later. However, we are making the conversion in the first place to take advantage of the known lower tax rates currently in effect. Things are not as they seem—it is, as if, something is rotten in Denmark (or D.C.).
First off, converting to a Roth IRA becomes more advantageous if tax rates rise. Whether we pay the tax from the IRA or not, we are in essence betting that taxes will go up. Taxes are at historically low levels. Many political and economic pundits say that ballooning deficits will put pressure on the Government to raise taxes.
Secondly, the current tax law expires on December 31, 2010. Unless Congress acts, tax rates will return to 2006 levels on January 1, 2011. Tax brackets shift from the current 10%, 15%, 25%, 28%, 33%, and 35% rates to 15%, 28%, 31%, 36%, and 39.6%. Taxes on capital gains and dividends will rise, and certain credits will cease or be reduced.
Barring the unknown of Congressional action, we know the tax structure will be higher in 2011 and 2012 than it is in 2010. Unless a taxpayer knows that his taxable income will be significantly lower in the latter years, it makes sense that he pay taxes on the conversion in 2010. (As a broad supposition, if many taxpayers convert great amounts of IRA dollars and choose to pay the tax with their 2010 returns, it may ease the pressure on Congress to raise taxes in 2011 or 2012 beyond the de facto increases in place.)

Diversify, Diversify, Diversify

Investment advisors recommend that we diversify across asset classes to reduce purchasing power risk. They recommend we diversify within asset classes to reduce systematic risk. They recommend we diversify among banks and insurance companies to reduce unsystematic risk. We now have an opportunity to diversify among taxable, tax deferred and tax favored ownership to reduce income tax risk.
We know that mechanisms are in place to change taxes in the future, as they have changed over the past 100 years. Tax deferred assets such as qualified plans and IRAs are exposed to future tax risk. Taxable assets are exposed to both current tax risk and future tax risk. Roth IRAs (and their similar ownership forms such as 529 plans) are exposed to current tax risk, but avoid future tax risk—barring an outlying event such as a retroactive tax law change. As our assets accumulate in tax deferred ownership, we become over-weighted in future tax risk. Roth IRA conversions allow us to diversify this risk, just as we attempt to diversify to reduce the other risks.

What Good Hath Roth?

On May 24, 1844, Samuel P. Morse officially opened the Baltimore – Washington telegraph service by sending the message "What hath God wrought?" The telegraph led to the telephone. The telephone led to the cell phone. Following the trail of the cell phone leads to my teen-age daughter. I too lament, "What hath God wrought?"
Moving from the meta-physical and inter-personal to the financial, we can ask: "What good is a Roth IRA?" I admit that, when Roth IRAs were introduced, I thought they were a ploy to get people to pay taxes sooner rather than later. Looking more closely at the provisions and the mechanics of this ownership form has convinced me that Roth IRAs have a place in most people's retirement portfolio.


Roth IRAs were created by the "Taxpayer Relief Act of 1997." Under the Act, an individual may establish an IRA under which all distributions are free from federal income taxation if certain conditions are met. There is no income tax or penalty tax on distributions if the Roth IRA has been in existence for five years and the owner would qualify for a penalty-free withdrawal from a Traditional IRA—the owner attaining age 59 ½ being the most common qualification. After the five year period, contributions can be withdrawn income tax and penalty tax free even if the owner is younger than 59 ½. If a distribution is made from a Roth IRA without meeting the requirements, there is a 10% penalty tax on it plus income tax is owed on any portion that wasn't previously taxed.
One feature of a Roth IRA is that it is not subject to the Required Minimum Distribution rules as long as it's owned by the Contributor or spouse. Non-spouse beneficiaries may maintain the Roth IRA in its tax-free state, subject to a new 5-year hold and Required Minimum Distributions. A non-spousal beneficiary has to take the balance of the account within 5 years, or start lifetime payments before the end of the calendar year following the year of the contributor's death. Generally, there are no IRD issues involved. Additionally, since they bypass probate, Roth IRAs can be an efficient way of passing assets to heirs.
There is a catch to Roth IRA contributions. A married couple cannot make a contribution to a Roth IRA if their Modified Adjusted Gross Income (MAGI) is over $176,000 ($120,000 if single). A conversion of a Traditional IRA to a Roth IRA is prohibited if the taxpayer's MAGI is over $100,000 (married or single). (This limit to conversions is removed as of 1/1/2010 by TIPRA. See "The Roth of Con(versions).")

Pay Now or Pay Later?

Whether it is financially advantageous to convert to a Roth IRA or not is based on tax rates at the time of conversion and at the time of withdrawal. For comparison purposes, let us assume that a 50-year old has $100,000 in a Traditional IRA and is in the 35% marginal tax bracket. He will withdraw all of the funds in 20 years. If he converts to a Roth IRA, he will owe $35,000 in taxes, which he has available in a taxable account. Let us further assume that all accounts earn 6% annually, although the taxable account pays tax on its growth annually. He can either keep the $100,000 in the Traditional IRA and pay taxes on withdrawal, plus have $35,000 grow at an after tax rate; or, he can convert the $100,000 to a Roth IRA and pay the $35,000 in taxes now. On the day after he converts the funds he is either in a much lower (15%), lower (28%), same (35%), higher (42%), or much higher (55%) tax bracket. The table below shows the after-tax outcome of these five scenarios.

Roth IRA
After-tax Traditional IRA + Taxable Fund
Much lower tax rate
$272,607 + $94,650 = $367,257
Lower tax rate
$230,914 + $81,549 = $312,463
Same tax rate
$208,464 + $75,228 = $283,692
Higher tax rate
$186,014 + $69,374 = $255,388
Much higher tax rate
$144,321 + $59,632 = $203,953

For the Traditional IRA + Taxable Fund to equal or exceed the value of Roth IRA, the marginal tax bracket must drop 9% or more immediately after the conversion.
Now, let us assume that the 50-year old wants to consider a Roth conversion, but doesn't have funds to pay taxes with, other than the IRA. He will owe ordinary income taxes plus a 10% penalty tax on funds withdrawn to pay taxes. This time, we assume tax rates change some time before withdrawing everything from the Traditional IRA in 20 years. Using the assumptions above, we have the following outcomes:

Roth IRA - Taxes
After-tax Traditional IRA
Much lower tax rate
Lower tax rate
Same tax rate
Higher tax rate
Much higher tax rate

Even with the 10% penalty tax, it does not take much of a tax increase to make the Roth IRA worth more. A tax increase of 4% or more makes the Roth IRA beneficial, even if taxes are withdrawn from it.
The conclusion we can draw from this analysis is that: (1) if a Traditional IRA participant has outside funds to cover the taxes, a Roth IRA Conversion is advantageous as long as tax rates do not drop more than 9% immediately after conversion; (2) if a Traditional IRA partyicipant pays for the conversion from the Traditional IRA and incurs the 10% penalty tax, the Roth IRA Conversion is still beneficial if taxes rise 4% or more by the withdrawal date. These conclusions do not necessarily apply to new contributions—we are analyzing Roth Conversions only.

Take Backs; or, A Question of Character

We have looked at a number of "what-if's." Here is another "what-if": What if an IRA owner converts an IRA early in the year and the value goes down after that. For example, on January 2nd the owner converts a $100,000 IRA to a Roth IRA. On December 1 the Roth IRA is worth $60,000. The owner would have a tax liability on $100,000 but would get no benefit from 40% of that liability (the tax paid on the value that disappeared). Fortunately, you can "take-back" a Roth Conversion as long as it is done by the filing deadline. This process is called re-characterization. The IRA custodian will have forms that provide the proper information to perform a re-characterization acceptable to the IRS.
Let us follow the mechanics of conversion and re-characterization. The owner converts a Traditional IRA to a Roth IRA in January, 2010. (The earlier in the year that you convert the IRA, the more time you will have to take advantage of any tax planning.) On April 1, 2011, he compares the Roth IRA's value to its conversion value. If the Roth IRA is higher, he pays tax on the lower conversion amount when he files his taxes. If the Roth IRA is lower, the owner re-characterizes it back into a Traditional IRA and cancels the tax liability. Re-characterizations take two weeks or more, so the owner wants to allow time to act before he has to file, although a taxpayer can also file for an extension to file as late as October 15th.
If the owner re-characterizes the IRA, the money is back in a Traditional IRA but he wants it in a Roth IRA. The tax law says that re-characterized money can be re-converted by the later of the start of a new tax year or 30 days. The owner initially converted the IRA in the 2010 tax year. The money was re-characterized by April 15, 2011 for the 2010 tax year. Since he is past the end of the tax year, he waits 30 days and converts the Traditional IRA to a Roth IRA on May 15, 2011. The owner will pay taxes on the IRA's value when he files his taxes for 2011. Since the value is lower than when he initially converted the IRA, he will owe less tax on the conversion.
Setting aside the politics of deciding when we want to give the Government money to use or waste, Roth IRAs are an advantageous ownership form for most persons' retirement. They are an excellent estate planning tool: the owner is not forced to dissipate a Roth IRA through Required Minimum Distributions; Roth IRAs pass outside of probate as long as the estate is not the beneficiary; and, they can maintain their tax-free status for the heirs. Congress has made provisions that make converting a Traditional IRA to a Roth IRA especially advantageous in 2010. See the article "The Roth of Con(versions)".

Thursday, November 19, 2009

Goldman Sachs, Buffett to help small businesses

Goldman Sachs teams with Warren Buffett on $500 million effort to help small businesses
Yahoo! Finance
  • On 10:57 pm EST, Tuesday November 17, 2009
NEW YORK (AP) -- Goldman Sachs Group Inc. is teaming with billionaire investor Warren Buffett to invest $500 million to provide thousands of small business owners across America with college scholarships and boost their access to capital.
AP - FILE - In this March 27, 2009, file photo, Goldman Sachs Chief Executive Officer Lloyd Blankfein leaves the ...AP - FILE - In this March 27, 2009, file photo, Goldman Sachs Chief Executive Officer Lloyd Blankfein ...
The move comes as the company has been criticized for setting aside billions for employee paychecks despite the continuing weak economy.
Goldman's philanthropic effort, called "10,000 Small Businesses," includes a $200 million contribution to community colleges, universities and other institutions to give grants to small business owners to further their education.
The New York-based bank also will invest $300 million through a combination of lending and charitable support. Goldman said the money will be funneled through community development financial institutions to boost lending and technical assistance available to small businesses in underserved communities.
In addition, Goldman Sachs executives, in partnership with national and local business organizations, will aid small businesses with advice, technical assistance and professional networking opportunities.
An advisory council co-chaired by Goldman Sachs CEO Lloyd Blankfein will oversee the program. Legendary investor and Goldman's largest shareholder, Warren Buffett, and Harvard Business School Professor Michael Porter will serve as co-chairs as well. …
10,000 Small Businesses, which has been in development for nearly a year, is a five-year program modeled on the Goldman Sachs 10,000 Women initiative, which creates partnerships between academic institutions and non-profits to provide business and management education to women around the world.
Other Council members include George Boggs, president and CEO of the American Association of Community Colleges, Glenn Hubbard, dean of Columbia Business School and Marc H. Morial, president and CEO of the National Urban League, among others.
The first community college to participate will be LaGuardia Community College in New York City's Queens borough, which houses a Small Business Development Center. The first community development financial institution to receive financing from Goldman Sachs will be New York-based Seedco Financial Services Inc., with loans to underserved businesses in the New York area expected to begin early next year.

Wednesday, November 18, 2009

Obama Tax Credit May Cause Millions to Owe More Taxes

Financial Planning magazine


November 17, 2009

The Making Work Pay Credit, a tax credit that was a signature part of President Obama’s economic stimulus package in February, could lead to more than 15.4 million people owing additional taxes, according to a new government report.

… The credit is advanced to taxpayers by their employers through reduced withholding, resulting in an increase in take-home pay.

The Treasury Department’s Inspector General for Tax Administration said in a new report that the implementation of the tax credit creates the possibility that millions of taxpayers may be advanced more of the credit through reduced withholding than they are entitled to receive. When filing their tax returns for 2009 and 2010, such taxpayers may ultimately owe additional taxes.  Some also may be subject to estimated tax penalties.

The MWPC was implemented using new income tax withholding tables. However, the changes to the withholding tables did not take into consideration the dependents who receive wages; single taxpayers with more than one job; and joint filers where one or both spouses have more than one job or both spouses work. Other groups potentially affected include: individuals who file a return with an Individual Taxpayer Identification Number; those who receive pension payments; and Social Security recipients who receive wages. …

“While implementing a credit through reduced withholding is an effective way to provide economic stimulus evenly throughout the year, it is difficult to account for everyone’s circumstances,” said TIGTA Inspector General J. Russell George in a statement. “More than 10 percent of all taxpayers who file individual tax returns for 2009 could owe additional taxes because their withholdings were reduced by more than the Making Work Pay Credit. If corrective actions are not taken, this problem will continue to plague taxpayers in 2010.”

TIGTA recommended that the IRS increase media coverage, consider ways of advertising other than the media already being used, and target communications to taxpayers who may be adversely affected as a result of the MWPC. TIGTA also recommended that the IRS use the withholding tables that were in effect before the enactment of the Recovery Act for pension payments in order to prevent pensioners from being negatively affected by the MWPC.

The IRS agreed with TIGTA’s first recommendation and plans to take corrective action. However, the IRS did not agree with the second recommendation, claiming that it would be burdensome and costly.

Monday, November 16, 2009

Retirement income – the axiomatic case for annuities

J.P. Morgan Compensation and Benefit Strategies

Nov 12, 2009

… In this article we lay out the axiomatic case for annuities as the investment instrument for providing retirement income. Summarizing: where, over any particular period, the objectives are to maximize lifetime income without risking the possibility that you will outlive your assets, an annuity (vs. self insurance alternatives) will always provide the greatest income. …

Longevity risk – the unpleasant choices for those blessed with long life

… Longevity "risk" … is the risk of being old and poor. Not, say, age 70 and poor … . Instead, we're talking about being, say, 85 or 90 and poor. … [Poor] because the individual lived longer than he or she expected. The retirement savings have been spent, and the individual now has nothing.

What are the choices?

We are going to consider three different general strategies for dealing with longevity risk:

  • "ignoring" it, that is, depending on someone else (family, Social Security, state welfare systems) to finance it;

  • self-insuring;

  • or buying an annuity.

Ignoring longevity risk

If an individual is old and doesn't have any assets, one (or more) of three things happen. Either he or she: (1) moves in with his or her children or other family; (2) lives off of Social Security; and/or (3) lives on some combination of state welfare programs (e.g., a state-provided nursing home). Let's consider each of these alternatives in turn.

1. Living with family. The retiree may have a large and strong family, with a tradition, for instance, of grandparents living with parents and children. … [He] or she is also likely to have a positive motive in favor of preserving retirement assets for a legacy. If the individual does not have family members he or she can realistically live with, then alternative 1 is not a solution to longevity risk.

2. Living off Social Security. … In 2009 [the maximum] benefit is about $2,300 per month. If the individual lives in a low cost-of-living community and is prepared to get by on "very little," then alternative 2 may work.

3. State welfare. Finally, some states and municipalities have quite livable publicly funded "old age" homes. … At least at this time, in this country, there is still a safety net.

Realistically, if the individual is going to ignore longevity risk, i.e., not insure (either with an insurance company or self-insure) against outliving personal retirement resources, he or she is probably counting on some combination of alternatives (2) and (3) and perhaps, depending on family circumstances, alternative (1). …

What is self-insurance?

… Let's assume that you are primarily concerned about the risk of living to age 95. If you live past 95, then somebody is just going to have to take you in. … In that case, self-insuring simply means spending your resources at a rate that (more or less) insures that you will have income through age 95. …

… For purposes of this article we're going to assume that the typical individual, at 65, assumes that he or she is going to live into his or her 80s and is prepared to consider, at least, self-insuring for that period – say, 20 years. So that the individual will spend his or her resources at such a rate that they will last at least until age 85.

What is an annuity?

As we use the term in this article, an "annuity" is a guarantee by some other entity (e.g., a pension plan or an insurance company) of a specific income "for life," that is, with payments beginning on some date and continuing until you die.

Rate of return

… For purposes of this article we're going to assume the same investment return (generally 5% per year) for all purposes: whether you're ignoring longevity risk, self-insuring or buying an annuity. …

… This is not the place to discuss alternative return strategies. Suffice it to say, identical alternative return strategies can be pursued either via self-insurance or an annuity vehicle, that is, in a variable annuity. Thus, the return strategy itself should not affect the relative efficiency of self-insurance and annuities. As a general matter, our conclusions hold whatever rate of return you assume, provided it is the same for whatever longevity risk strategy you pursue.

Comparing alternatives

Let's now quantify the financial alternatives available for mitigating longevity risk – self-insurance vs. annuity.

Let's assume you have $1 million, are age 65 and in average good health. … Let's consider four alternatives: (1) you self-insure for the period age 65 to 85 and disregard longevity risk thereafter; (2) you self-insure through age 95; (3) you self-insure for the period age 65 to 85 and buy an annuity for the period after age 85; or (4) you buy an annuity beginning at age 65 (the number provided here is for a DB plan, not a retail annuity).

The following table summarizes the results for each alternative.

Alternative--Income per month

Self-insurance age 65 to 85--$6,512

Self-insurance age 65 to 95--$5,279

Self-insurance age 65 to 85 + annuity 85-death--$6,091

Immediate annuity beginning at age 65 DB plan--$6,945

Explaining these results

…Self-insurance age 65 to 85 – means you spend all your money, at a rate of $6,512 per month, to age 85. If you live past that age, someone else has to pay your living expenses.

Self-insurance age 65 to 95 – means you spend all your money, at a rate of $5,279 per month, to age 95. As discussed, this is more or less the equivalent of fully self-insuring longevity risk, that is, survival past age 95 can be realistically ignored.

Self-insurance age 65 to 85 + annuity 85-death – means you take some of your $1 million (about 6-7% to be precise) and buy, at age 65, an annuity that is payable for life beginning at age 85. This annuity is relatively cheap, because it doesn't pay anything unless you at least survive to age 85. You then take what's left over and spend it, at a rate of $6,091 per month, to age 85.

Immediate annuity beginning at age 65 – means just a regular old garden variety life annuity. As indicated, our immediate annuity number is based on what you would get out of a DB pension plan using current "standard" actuarial assumptions. Insurance company and regulatory overhead will add costs to annuities and bring the annuity income number down somewhat.

Tax effects

In our analysis we have generally disregarded tax effects. And, assuming our $1 million starts out in a qualified plan or IRA, taxation under self-insurance or an annuity will be, for the most part, identical. We say, "for the most part," because we have ignored two elements of the tax code that, in fact, further skew results in favor of annuities.

First, money held in a qualified plan or IRA, unless it's rolled into an annuity, must be distributed at a specific minimum rate (with a lot of oversimplifications, over the participant's life expectancy). At a stretch, those minimum distribution rules would permit a distribution over 20 years, i.e., allowing self-insurance over the period age 65 to 85. They would generally not permit distribution … under an age 95 self-insurance strategy, some tax-advantaged money would have to be distributed early and held in a taxable account.

Second, the after-tax rate of return on a taxable account (e.g., a garden variety bank or brokerage account) will be lower than the after-tax rate of return on a retail annuity. That's because the "inside build-up" on retail annuities is untaxed. …

When you put these two rules together, the annuity approach enjoys a tax advantage vis a vis self-insurance. Nevertheless, we regard that advantage as relatively marginal and have not taken it into account in our analysis.

Why are annuities such a better choice?

…Given those two objectives, maximizing retirement income and minimizing the chance of outliving your savings, annuities are the most efficient investment because – all other things being equal – they share the risk of outliving savings within the annuity pool. …

*     *     *

… Reviewing it, you would think that everyone would buy one. But the fact is, very few individuals do. Consider – only 2% of the income of current retirees comes from private annuities. (Increasing Annuitization in 401(k) Plans with Automatic Trial Income; Gale, Iwry, John and Walker; 2008.)…

Compromised longevity

The foregoing, "axiomatic" case for annuities holds for someone in average good health. Clearly, if you realistically expect not to live to an average life expectancy – that is, your longevity risk is, for some reason, compromised – then you should generally not buy an annuity. …

Solvency risk

If you take the annuity approach, then a third party will be paying you an income for life. Generally that third party is either an insurance company or an employer-sponsored pension plan. Both insurance companies and (corporate) pension plans are subject to solvency rules – requiring them to fund benefits at certain minimum levels. Moreover, many states provide insolvency funds for insurance companies that go "bankrupt," and the Pension Benefit Guaranty Corporation generally insures corporate pension benefits up to certain minimum levels.

…Suffice it to say, if you are taking an annuity option, you will want to evaluate the possibility that, under some circumstances, the third party annuity provider might not be able to make payments.

Explanations focusing on aspects participant behavior

Concerns about compromised longevity and carrier insolvency risk cannot, however, explain the overwhelming rejection of annuities by participants. …

In recent years, the field of “behavioral economics” has provided insights as to why individuals do not always act in accordance with “rational” principles. … While we recognize the fruitfulness of this perspective, we are resistant to the idea that low uptake on annuities is simply a result of irrational decision-making. …

Individuals view early death as "losing" in an annuity system

If you look at the actuarial tables, over 15% of a typical age 65 annuity cohort will die in the first ten years. They will "lose" – by dying early – a significant portion of the value of their benefit. We put "lose" in quotes because the axiomatic argument does not regard this as a loss. The participant is dead and so does not need any more income. And the participant could have had no fixed legacy intention with respect to the "lost" money – if (as was in fact more likely) he or she had lived to a normal life expectancy, there would have been no money "left over" to leave to heirs and beneficiaries.

Our guess, however, is that people don't think like that. …[Human] beings are reluctant to take a substantial risk that money they worked hard for will simply go to strangers, even after they're dead. … Humans retain, and act on, a proprietary view of their money, even after their (anticipated) death. …

Annuities limit flexibility

Simply, if money is "locked up" in an annuity, there is no (or, at least, less) money available for emergencies or, for that matter, for something special.

Individuals place a lower value on life after 85

… More nuanced: a 65 year old does not regard the financial challenge presented by living past 85 as a particularly high priority. Perhaps an analog to this is the reluctance of young people (say, individuals in their 20s) to buy health insurance. In both cases, the likelihood of catastrophe – a health catastrophe for a young person or a longevity catastrophe for an old person – is small enough that the individual feels comfortable ignoring it. (This argument reflects the behavioral economics notion of “hyperbolic discounting.”)…

This is a publication of J.P. Morgan Compensation and Benefit Strategies. J.P. Morgan Compensation and Benefit Strategies is a part of JPMorgan Chase & Co. If you have any comments or questions, please contact your J.P. Morgan Consultant or Insight Editorial.

This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice. J.P. Morgan Compensation and Benefit Strategies is wholly owned by J.P. Morgan Retirement Plan Services LLC, an affiliate of JPMorgan Chase & Co.

IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.


email an expert!email an expert!

Thursday, November 12, 2009

Leading the Horse to Water

 Legislation may nudge plan sponsors to reconsider annuities—but what about participants?

Judy Ward


Illustration By Marco Wagner


The market's recent plunge likely frightened more Americans into a willingness to consider putting at least some of their 401(k) assets in a retirement-income product at retirement. Now, Congress may give them a nudge to go ahead with it.

Support for tax advantages for annuities, previously proposed in 2005 by Rep. Earl Pomeroy (D-North Dakota), seems low this year… However, several other ideas appear to have potential traction, and they speak to the logistical and psychological reasons that many see at the heart of 401(k) participants' continued aversion to retirement-income products—the overall inertia, concerns about the complexity and cost of choosing an annuity on the open market, the fear of losing money to unstable financial institutions, and the impression that a series of small payments made over time has less value than one big lump-sum payment.

"As we bring more people into the system, we will need to address the longevity risk," says David Certner, AARP's Director of Legislative Policy in Washington, pointing to the Obama Administration's auto-IRA push. "Having a better-functioning annuities market would be very helpful."

Three Possible Solutions

These three possibilities seem the most discussed currently:

Auto-enrollment in annuities: Nonprofit public-policy researcher The Brookings Institution has proposed a "test drive" that would automatically enroll defined contribution participants in an annuity for two years after they retire. …

A government mandate to purchase annuities "would be a step in the wrong direction," [William Gale, a Brookings Vice President and Director of the Retirement Security Project] stresses. An annuity does not work best for everyone, he says, and, even when it does work well, a bunch of variables mean no one annuity setup is right for everyone. "It is very important that these things remain voluntary," he says. If people get the wrong annuity, he says, they "have made a big, permanent mistake."…

From an employer perspective, sources agree, auto-enrollment succeeds in giving many more participants access to a retirement-income vehicle. With opt-out rates low for automatic enrollment in 401(k) plans, "it is not likely that they will opt out" of auto-enrollment in an annuity, says Robyn Credico, Arlington, Virginia-based National Director, Defined Contribution Consulting, at Watson Wyatt Worldwide. …

The concept has its challenges, though. "The problem is the pricing," says Dallas Salisbury, President and CEO of the Employee Benefit Research Institute (EBRI) in Washington. "You could do it—but it would be a very expensive option, because any annuity that can be terminated at the end of two years becomes very expensive to underwrite." …

Edward Ferrigno, Vice President, Washington Affairs, at the Profit Sharing/401k Council of America, also worries about any sort of annuity mandate. "We … fully support … a tremendous amount of innovation [by annuity­ providers], he says, but it would kill that innovation if they mandated something. "For insurance companies, that is a jackpot: 'We have your money, and you cannot get it back.'"

A federal guarantee: Some believe that automatic enrollment in annuities makes little sense without setting up a federal-guarantee structure for annuities, similar to the Federal Deposit Insurance Corp. (FDIC) guarantee of bank deposits. …

On the other hand, "One thing employers might be ­concerned about is that the whole arrangement would be ­subject to future changes by Congress," says Jan Jacobson, Senior Counsel, Retirement Policy, at the Washington-based American Benefits Council, "and it would be a fairly expensive proposition." Adds Salisbury, "Given the current fiscal situation, even if people said it was a good idea, it would take a long time to do."

Channeling employer contributions: Brookings' Gale also talks about using legislation to funnel employer contributions to an annuity. "It would be a default," he says. "[The idea is that] the employer has to offer it, but it is voluntary for the individual."…

Ferrigno does not favor the idea at all. "We would fight that to the death," he says, again mentioning a dislike of plan-design mandates. "If there was a demand for ­annuity products in a plan, they would be there.” …

"There is a lot of interest. The Administration is in favor of it, and I think Congress gets it," Gale says. "…The sea change coming is going to be to think of a 401(k) not as an asset-accumulation device, but a retirement-income-provision device."

Jacobson also sees interest in annuities in Washington, but does not expect a stand-alone bill. … U.S. Rep. George Miller (D-California), Chairman of the House Education and Labor Committee, was said at press time to be "in the middle of drafting a retirement bill that might or might not include annuities," Salisbury says. "Everything at the moment is dominated by the health-care discussion. The probability of that [retirement] bill getting enacted this year is probably zero," he predicts. "The question becomes, does it become a priority in 2010 and 2011, assuming they get health care done this year?"…

Judy Ward

Legislation provides incentives for annuitizing distributions

Bipartisan legislation has been introduced to give workers a new incentive to annuitize, rather than spend, their retirement savings. U.S. Representatives Earl Pomeroy (D-North Dakota) and Ginny Brown-Waite (R-Florida) have introduced The Retirement Security Needs Lifetime Pay Act, H.R. 2748, which would encourage workers to annuitize some of their retirement savings by providing a 50% tax exclusion for up to $10,000 of lifetime annuity payments annually.

Other Provisions

The bill also will exclude from taxes 25% of lifetime income payments from individual retirement accounts (IRAs), qualified plans, and similar employer-sponsored retirement savings plans other than defined benefit plans. …

"For years, the federal government has recognized its duty to assist American families in building a retirement nest egg," Pomeroy said in a press release. "Saving and investing for the long term is extremely important, especially in these challenging times. A greater retirement challenge lies ahead: managing assets to make sure that your retirement savings last a lifetime. The Retirement Security Needs Lifetime Pay Act will provide families with incentives to plan for a secure lifelong retirement."

Alison Cooke