Tag Archives: Jeff Bradley

Avoiding poverty in a DC-only world

Bradley_JeffIn a defined contribution (DC) world, retirees are forced to make critical decisions, often with little or no assistance. Most of these individuals choose to take a single lump-sum distribution either immediately or soon after they terminate employment.

This paper from the Center for Retirement Research at Boston College asserts that distribution provisions in DC plans are critical factors in evaluating the risk of falling into poverty in old age.

Specifically, the paper states that reliance on non-annuitized DC benefits with fairly easy access to lump-sum distributions puts elderly households at risk of not having sufficient income (or assets) to sustain themselves or, if they are not already in poverty at retirement, falling into poverty as the household members age or die off.

As workers continue to age, this will become a greater problem as those covered by defined benefit plans retire from the workforce and are replaced by those covered only by DC plans. So what can plan sponsors do to minimize the probability of their retirees falling into poverty?

Extrapolating from thoughts in the paper, the conclusion is that plan sponsors should encourage the following behaviors:

• Not taking lump-sum distributions before retirement
• Annuitizing some or all DC benefits when possible
• Choosing joint-and-survivor options when available

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When to begin Social Security: The conundrum

Bradley_JeffIn retirement planning, especially in discussions involving those who retired early or are thinking of retiring early, this question usually comes up: When do you plan to start taking Social Security?

To answer this question, we have to look at two alternatives:

1) If one defers payment to age 70 (currently the latest permissible date for increased benefits) or some other age, a higher monthly benefit is payable.
2) Instead, if one decides to commence payment early, say at age 62, the question then becomes how many years it takes to come out ahead by deferring. In other words, how many years does it take to reach the “break-even” point?

For example, a maximum earner, retiring at age 62 in 2015 could expect a monthly benefit of approximately $2,014. Instead, if he or she defers to age 70, that amount is estimated to be $3,544 (in 2015 dollars).

If we assume 2% CPI, the total benefits received from age 62 through age 78 are approximately $484,000. If deferred to age 70, the total benefits received from age 70 through age 78 are approximately $486,000. Thus, the breakeven point is somewhere between 16 and 17 years from age 62.

Why is it difficult to pick one or the other? Let’s examine the issues.

Many financial advisers suggest that a retiree would always be better off deferring commencement as long as possible as this maximizes the benefit. However, this may not always be the case and is really a decision that depends on several factors, many of them personal.

Obviously, to make the best decision, retirees will need to know if they (and their spouses, if applicable) will be alive at the “breakeven” point(s). Because no one knows the answer to this question, one possible approach would be to look at the present value of the two options at age 62. Using the current mortality table to calculate minimum lump sum distributions under the Internal Revenue Code and a 2% real interest rate assumption (note that the actual real rate of interest used will vary based on individual expectations), the present value of the benefit payable at age 62 to a single person is approximately $430,000 and the present value of the deferred benefit is approximately $452,000. However, if a 4% real interest rate is used, the present values are $347,000 and $327,000, respectively. Thus, the present value depends on the underlying assumptions which will vary by individual, making it somewhat subjective.

What about the “utility” of the immediate cash? In this regard, you should consider cash needs, both immediate and long-term. This would mean no Social Security cash now but more in the future versus some Social Security cash now but less in the future. We should note that it doesn’t do any good to have more money in the future if we aren’t alive or aren’t able to enjoy it. To assess cash needs, you will have to run the numbers because everyone’s situation is different.

Also, many proponents of delaying Social Security note that deferring it is a significantly lower-cost alternative than buying commercial longevity insurance. The key decision point here is that it shouldn’t matter which is a lower-cost alternative. What matters is whether longevity insurance is needed or wanted in the first place. If so, then deferring Social Security may be the right move. If you don’t want longevity insurance, deferring Social Security may not be the right move.

Don’t forget taxes! Social Security can be taxable to some individuals and can affect Modified Adjusted Gross Income (MAGI) which is used to determine eligibility for Federal tax subsidies under the Affordable Care Act.

And then we have the latest Social Security Trustee’s Report. Here’s an excerpt:

“The theoretical combined OASDI trust funds have a projected depletion date of 2033, unchanged from last year’s report. After the depletion of reserves, continuing tax income would be sufficient to pay 77 percent of scheduled benefits in 2033 and 72 percent in 2088.”

So what does this mean? Taking Social Security early may be the bird in the hand. Modeling a 23% haircut may be the deciding factor on whether Social Security should be taken as soon as possible. On the other hand, 2033 is a long way out, and we will have to wait and see.

GASB 74/75: Are you ready?

Bradley_JeffThe train has left the station and is on its way—the Governmental Accounting Standards Board (GASB) will shortly finalize standards 74 and 75, which will require for the first time that the net liability for publicly sponsored retiree healthcare plans (and other postemployment benefits) be stated on balance sheets.

GASB expects that final rules will be issued close to the end of June 2015.

It is expected that the new accounting treatments will mirror those of GASB 67/68, which require public sector plan sponsors, as well of those of cost-sharing employers, to book an accounting expense for sponsoring the plan and to show net pension liabilities on financial balance sheets.

GASB 67/68 also mandated the use of fair market value of assets and a standard actuarial cost method to be used to value net the net pension liability.

GASB 74, which relates to reporting by benefit plans, is expected to be effective for plans for fiscal years ending June 30, 2017, and later. This will replace the old GASB 43 standard.

GASB 75, which relates to reporting by state and local governments, is expected to be effective for fiscal years ending June 30, 2018, and later. This will replace the old GASB 45 standard.

In this regard, plan sponsors, especially those that have cost-sharing arrangements with contributing employers, should be ready to book a liability for fiscal years ending on or after June 30, 2017. In addition, liabilities and accounting expenses for contributing entities will need to be booked for fiscal years ending on or after June 30, 2018.

For unfunded plans, liabilities will be calculated using a discount rate equal to the yield for 20-year, tax-exempt municipal bonds with an average rating of AA or higher. For well-funded plans, an expected rate of return on assets may be used as long as the plan’s funding policy is expected to make or keep the plan fully funded. For plans in between, a blended discount rate will be used.

Many other changes are expected in the new standards. We recommend you contact your Milliman consultant for more details.

Top Milliman blog posts in 2014

Milliman consultants had another prolific publishing year in 2014, with blog topics ranging from healthcare reform to HATFA. As 2014 comes to a close, we’ve highlighted Milliman’s top 20 blogs for 2014 based on total page views.

20. Mike Williams and Stephanie Noonan’s blog, “Four things employers should know when evaluating private health exchanges,” can help employers determine whether a PHE makes sense for them.

19. Kevin Skow discusses savings tools that can help employees prepare for retirement in his blog “Retirement readiness: How long will you live in retirement? Want to bet on it?

18. The Benefits Alert entitled “Revised mortality assumptions issued for pension plans,” published by Milliman’s Employee Benefit Research Group, provides pension plan sponsors actuarial perspective on the Society of Actuaries’ revised mortality tables.

17. In her blog, “PBGC variable rate premium: Should plans make the switch?,” Milliman’s Maria Moliterno provides examples of how consultants can estimate variable rate premiums using either the standard premium funding target or the alternative premium funding target for 2014 and 2015 plan years.

16. Milliman’s infographic “The boomerang generation’s retirement planning” features 12 tips Millennials should consider when developing their retirement strategy.

15. “Young uninsureds ask, ‘Do I feel lucky?’” examines the dilemma young consumers face when deciding to purchase insurance on the health exchange or go uninsured.

14. Last year’s #1 blog, “Retiring early under ACA: An unexpected outcome for employers?,” is still going strong. The blog authored by Jeff Bradley discusses the impact that the Patient Protection and Affordable Care Act could have on early retirees.

13. Genny Sedgwick’s “Fee leveling in DC plans: Disclosure is just the beginning” blog also made our list for the second consecutive year. Genny explains how different fee assessment methodologies, when used with a strategy to normalize revenue sharing among participant accounts, can significantly modify the impact of plan fees in participant accounts.

12. Doug Conkel discusses how the Supreme Court’s decision to rule on Tibble vs. Edison may impact defined contribution plans in his blog “Tibble vs. Edison: What will it mean for plan sponsors and fiduciaries?

11. In her blog “Retirement plan leakage and retirement readiness,” Kara Tedesco discusses some problems created by the outflow of retirement savings. She also provides perspective on how employers can help employees keep money in their plans.

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The tontine pension plan: A defined benefit panacea?

Bradley_JeffConsider a retirement plan with the following characteristics:

• The plan provides an adequate stream of lifetime payments to plan participants
• Plan sponsors have a fixed contribution to the plan (just like a defined contribution plan)
• Plan sponsors have no investment, longevity, or other actuarial risks
• The plan is always fully funded

Sounds too good to be true doesn’t it? It turns out that the tontine pension plan has all of these characteristics. This paper by Jonathan Barry Forman and Michael J. Sabin discusses the inner workings of such a plan and how the above four characteristics come to fruition. The paper goes on to suggest that the tontine pension plan can solve the public sector pension underfunding crisis.

Never heard of a tontine? Then you are not alone. Simply put, a tontine is a financial arrangement where each member (usually the same age) contributes an equal amount. The total is awarded entirely to the sole survivor. Tontines were actually quite popular prior to the 19th century. In the early 1900s, however, the state of New York passed legislation that all but outlawed tontines, and other states followed.

While the paper doesn’t suggest that we lobby to resurrect pure tontines as financial instruments, it does suggest that we use the tontine concept to create a type of pension plan—the tontine pension plan.

The concept is simple. An employer contributes a fixed amount per year to an employee’s account; this account, managed by the employer, accumulates to a fund which, upon retirement, is converted to an annuity benefit payable to the employee. When the employee dies, the remainder of his or her “fund” or “reserve” is then redistributed to the remaining retirees. Actuarial principles ensure that amounts annuitized and subsequently redistributed upon death are done in a fair and equitable manner. Age is used to compute life expectancies, probabilities of death, and the associated fair transfer values.

Participant accounts are adjusted upward or downward based on the trust’s investment earnings. Adjustments are also made to the accounts for mortality gains and losses. Thus, the participants bear all of the investment risk as well as the longevity and other actuarial risks. All the plan sponsor has to do is contribute the fixed amount per annum.

While there are certain issues that would need to be worked out for the tontine pension plans to work in an ERISA environment—mandatory qualified joint and survivor annuity (QJSA), qualified optional survivor annuity (QOSA), or qualified preretirement survivor annuity (QPSA) benefits, for example—most of these issues generally do not exist in public sector plans.

Can such a plan solve the public sector pension funding crisis? Not by itself. In order to accomplish that objective, existing underfunded levels would need to be shored up through increased contributions, investment earnings, and/or cuts to benefits. However, once the underfunding is shored up, the tontine pension plan would prevent such deficits from happening in the future. Going forward, the tontine pension plan may be just what the doctor ordered.

Top 10 Milliman blogs items for 2013

Milliman publishes blog content addressing complex issues with broad social importance. Our actuaries and consultants offer their perspective on healthcare, retirement plans, regulatory compliance, and more. The list below highlights Milliman’s top 10 blogs in 2013 based on total pageviews:

10. In their blog “Five keys to writing a successful qualified health plan application,” Maureen Tressel Lewis and Bonnie Benson highlight several best practices insurers should consider when submitting a qualified health plan application to the Health Insurance Marketplace.

9. “Understanding ACA’s subsidies and their effect on premiums” offers perspective into the relationship between healthcare premiums and federal subsidies for low-income individuals.

8. Funding for future Consumer Operated and Oriented Plans(CO-OPs) was eliminated as a result of the fiscal deal that was signed in December 2012. Tom Snook takes a look at how the deal affects CO-OPs in his blog “CO-OPs: An endangered species?

7. Robert Schmidt discusses why the methodology used to determine COBRA premium rates is essential in his blog “The growing importance of COBRA rate methodologies.”

6. A second blog by Maureen Tressel Lewis and Mary Schlaphoff entitled “Five critical success factors for participation in exchange markets” highlights tactics that insurers offering qualified health plans may benefit from implementing.

5. “Pension plans: Key dates and deadlines for 2013” offers Milliman’s three retirement plan calendars (defined benefit, defined contribution, and multiemployer) with key administrative dates and deadlines throughout the year.

4. In her blog “Fee leveling in DC plans: Disclosure is just the beginning,” Genny Sedgwick explains how investment expenses and revenue sharing affect the fees paid by defined contribution plan participants.

3. Maureen Tressel Lewis and Mary Schlaphoff’s blog “Five common gaps for exchange readiness” describes items issuers of qualified health plans have to resolve before their plans can be sold on the Health Insurance Marketplace.

2. In the lead up to implementation of the Patient Protection and Affordable Care Act (ACA), debate often centered on how the law would affect healthcare premiums. Our “ACA premium rate reading list” offers perspective on how rates may be affected.

1. In his blog “Retiring early under ACA: An unexpected outcome for employers?,” Jeff Bradley discusses the impact that the ACA could have on both early retirees and plan sponsors.

This article was first publish at Milliman Insight.