Monthly Archives: January 2011

On the right trajectory

Motley Fool takes the glass-half-full view to the most recent pension funding status results:

The pension deficit actually shrunk by $44 billion in December, thanks in part to the stock market’s recent growth. In the last quarter, an 11% increase in the S&P 500 helped prompt a 7% increase in the value of pension funds.

For the full article: “Pension Perils Take a Turn for the Better.”

The Roth question: Should I pay or should I stow?

Timothy Connor

Your employer offers you the opportunity to make contributions to a Roth 401(k). You may even have the choice to convert the current balance in your regular 401(k) into a Roth 401(k). So should you? 

It goes without saying the key questions involve tax implications.  After all, you’re deciding whether to pay taxes now or perhaps pay them later on an investment.  Let’s put aside for a moment estate planning and other special circumstances where Roths are very effective. In a more general use, there exists a common viewpoint that warrants some scrutiny. It goes something like this:  “I think tax rates are going to increase. Therefore, I should go Roth now.” Hmm, is that the right way to go? 

Perhaps not. Rather than just trying to guess which way tax rates will move, you may wish to consider the difference between your “marginal” tax rate today versus your “effective” tax rate in retirement.

Your marginal tax rate today is the tax bracket that would apply to your next dollar of income. A single filer making $200,000 is in the 33% marginal tax bracket, meaning a raise to $200,001 would result in an extra 33 cents of taxes. However, because of our progressive tax system, the effective tax rate we pay is a combination of all the tax brackets that apply to our income (only 25.4% for the single filer making $200,000). When you contribute to a Roth instead of a regular 401(k), you’re effectively adding a slice to the top of your income, which gets taxed at your marginal tax rate. In retirement, your income may be comprised of virtually nothing but annual distributions from your retirement balances. And so the question to consider is this: When you take those retirement distributions, how will the effective tax rate you’ll pay on that income compare to the marginal tax rates you were subject to at the time you were deciding to go Roth or not? Even if you predict tax rates will increase, you may have been better off not going Roth. 

It’s not a simple subject, and certainly not as simple as laid out here, as there are many other factors involved including state taxes, account purposes, and other retirement assets. If you talk to experts, or search for help online, you’ll find arguments for either side. Many individuals in many situations are better off with Roth. Read up as much as you can. Ultimately, it’s a question you should explore with your tax planner and financial advisor.

DISCLAIMER: This post is for informational purposes only. Milliman does not provide tax advice. For more, see our terms of use.

Take this retirement advice from a wise 107-year-old!

Tony DozierRetirees who exited the workplace just before the downturn were probably counting on a different retirement experience. As the economy starts to come back, they have one of two choices according to this article, “Increase Your Odds of Surviving Retirement”: increase their income (by getting a part-time job for example) or cut their expenses.

Or you can take this advice from a 107-year-old who has been retired since 1969. Leonard McCracken lives in Florida and shares the reasons for his success: thrift, minimal use of debt, health, etc. Now that’s what you call a successful retirement.

Pension funding relief elections may require immediate action

Milliman has released a new Client Action Bulletin (CAB) looking at single-employer pension funding relief elections. Plan sponsors have only a brief window to formally make an election for either the 2009 or 2010 plan year.

This new CAB focuses on the IRS’s guidance on electing the relief, the calculation of the reduced contribution, and the notifications. You’ll find the new CAB here.

Comeback for long-term corporate bonds?

The Wall Street Journal looks at the possibility that increased M&A activity (and maybe even an increase in the currently low interest rates) could contribute to an increase in the issuance of long-term corporate bonds. What implications would this have for pensions?

Pension funds may be more motivated to increase their allocations to bonds now because they are better funded thanks to improvements in their stock portfolios. Their funded status, a measure of how well their assets match their liabilities, has risen to 79.8% from a 10-year low of 70.1% in August, according to consulting firm Milliman Inc.’s Pension Funding Index.

Since new 30-year issues have been hard to come by, pension funds and insurance companies that want to own longer assets have been picking them up in the secondary market.

Pension funded status up for month, down for year

Milliman today released the latest update to the Milliman 100 Pension Funding Index, which consists of 100 of the nation’s largest defined benefit pension plans. In December, these plans experienced asset increases of $24 billion and liability decreases of $20 billion, resulting in a $44 billion increase in pension funded status for the month. For the year, these pensions experienced asset increases of $50 billion but a liability increase of $99 billion, increasing the pension funded status deficit by $49 billion.

“The year started strong but then came the massive liability increases of this summer, which took us to a ten-year low in pension funded status,” said John Ehrhardt, co-author of the Milliman 100 Pension Funding Index. “A market rally and generally positive interest rate performance since August has helped make up for that all-time low but it wasn’t enough to counteract the ballooning pension obligation. Looking to 2011, these 100 plans sponsors face an estimated $4 billion in additional  pension expense.”

You’ll find the full report here. Plan Sponsor’s coverage is available here. UPDATED 1/18: Treasury and Risk is available here.

And here are the ten-year deficit/surplus figures:

Is your deferral strategy achieving maximum results?

Darlene Laursen

The new year has arrived and, with 2011 in full view, you may be faced with the question: Does it make sense to defer the maximum limit of $16,500 (or $22,000 if you are over age 50) into your 401(k) plan, as early as possible or is it better to spread it out over the entire year? Some of us like to get the full deferral out of the way and into the plan as soon as possible to achieve the longest period of investment towards retirement. However, I think the more important question to ask yourself should be: How does the employer match work in my plan? More specifically, does my plan “true up” employer matching contributions by plan year or by payroll?  

If you know the answer to this question, you are already ahead of the game. If you are not sure of this answer, now may be the time to find out. 

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Four big questions on the state of today’s defined benefit plan

Bart Pushaw

Questions continue to swirl about the relative merits of defined benefit (DB) and defined contribution (DC) retirement plans, particularly in the aftermath of the global financial crisis and the still-tentative recovery. In many ways, DB plans are looking better than ever. What follows is a Q&A that should help to characterize the current lay of the land.

Q: What caused defined benefit (DB) plans to become less prominent?

A: Several issues arising have caused the decline in DB plan incidence. First, they were hard if not impossible for average employees to understand—no understanding implied no appreciation. Second, the plans were decried as less portable than others. Third, DB plans were labeled paternalistic and entitlement-based. Fourth, they were considered too costly.

Q: How do these complaints stack up today?

A: Let’s address them in order. First, it’s true that some benefit formulas were ridiculously complicated even by actuarial standards: multiple fractions, ratios, definitions, averages, social security amounts, lump sum factors. Today, those just aren’t necessary or very common. An account balance with interest and additions are all that’s seen by many participants, thus relying on the same universal math knowledge claimed to make defined contribution (DC) plans so easy to understand. The second and third reasons now appear to be mere confiscations devised to drive change. Portability, for example, was often undefined and actually is a benefit structure rather than plan type issue—portability can be supported or inhibited by DB and DC plans alike. Fourth, cost levels were originally established under very different regimes with different goals. Cost levels of DB plans were high relative to DC plans because the DB was central and the DC plan an add-on to help employees save additional funds, “mad money,” and to use as inflation hedges. Also, many plans had original cost levels reset during the ’80s when high interest rates made doing so appear cost-free. The underlying cost level can be dialed down or up to any level chosen at generally any time. A sideways view of cost level is cost volatility. We now have tools and a regulatory structure that enables us to significantly reduce and better manage cost volatility, enough to make it a non-issue for most of our clients.

Q: If the negatives are gone or suppressed, are there still any good reasons to adopt a DB plan?

A: The main reason these plans became so widespread remains true today: DB plans are more efficient in delivering retirement income security. For example, for a typical company and employee group, the DB plan can deliver upwards of twice the retirement benefit of a DC plan.

Q: Are we seeing widespread recognition of these benefits today?

A: As misinformation is disputed and recent successes identified and affirmed, we have seen a thoughtful reconsideration of plan sponsorship. There are still good cases when DB plans aren’t right for a company or employee group, but there are many more when it is. 

The risk of outliving your assets

The Society of Actuaries (SOA) released the results of a new study today indicating that nearly half of Americans have no plans in place should they outlive their assets. This is one of several topics of discussion at the “Living to 100 Symposium” scheduled for this week. Here is an excerpt from the SOA’s press release:

“While living past one’s expected age can mean more time with family and friends, it can also pose potential financial, physical and societal risks,” says Timothy Harris, FSA, MAAA, symposium co-chair and principal at Milliman. “At this year’s Living to 100 Symposium, experts will present more than thirty papers, which address these issues, and will work together to find some potential solutions to help people mitigate and prepare for those future unforeseen risks.”