The growing wave of retiring baby boomers is putting the issue of retirement funding and assets front-and-center. Congress continues to tinker with pension rules, and plans are drawing more scrutiny from agencies looking to ensure that they’re going by the book. The Department of Labor recently hired 1,000 investigators to deal with employee benefits. The IRS has always audited between 1 and 2 percent of retirement plans and they continue to do so. And the Pension Benefit Guaranty Corporation has been beefing up its enforcement ranks. The oversight is needed because the rules are getting more complex and so it’s getting harder to stay in compliance.
Retirement plans that effectively trade tangible, taxable income for a long-term investment prospect look increasingly attractive as tax rates creep up and more loopholes are closed for higher earners. There are few better, easier ways to take a slice of income and shield it from federal, state and local taxes. With the federal top rate going from 35 to 39 percent, the Alternative Minimum Tax snaring more people, Medicaid taxes going up on high earners, and states like California upping their top rate to 12.3 percent, legal tax avoidance is a growing aspiration. It’s almost a binary choice: Give the money to the government or save it in a retirement account. As a result, the pace of plan establishment is higher than it’s been in many years.
With the realization that most people lack the skills and temperament to manage their own investments, more plans are moving to structures that recognize that. The typical 401(k) plan wrongly assumes that people can make the right investment and portfolio allocation decisions. That’s been a massive failure. So what’s happening now in the more progressive plans is that participants are being offered both fewer and better choices increasingly in the form of target-date funds. These investments change their allocations over time automatically, theoretically becoming more defensive as a protective strategy as time goes on. Moreover, these types of investments are increasingly structured as the default choice for those who can’t or won’t choose an option that requires participant management.
Cleverly hidden fees, especially on the plan investment management side, are more out in the open now. The financial services industry is supposed to follow “full fair and disclosure” when it comes to fees, but asking it to start doing that in a consumable way is like asking your cat to speak Swahili. Fees have actually been coming down as competitors vie for more business. Yet out-of-line costs continue to plague many plans. Competent plan advisors and managers are doing a better job of rooting out these fees and finding less-costly alternatives. We’re now at the point where it’s very likely that a plan that hasn’t been redone in five years is probably paying too much. And that’s a potential problem for plan administrators since of their key fiduciary duties is ensuring that fees meet the “reasonableness” test.
Fearing unfunded liabilities, more plan sponsors are moving away from plans that essentially put them on the hook for a stated amount of money to be paid out in the future. Boards are always worried about putting their companies in the position of not being able to meet future financial commitments. Pension plan assumptions can change a company’s profitability picture, and carrying one can be a weighty thing that keeps a company from being nimble. For the most part the only defined-benefit plans getting set up these days at small and midsized companies are less risky cash-balance plans that define the benefit based on an actual, stated account balance at the end of a term. That’s different from owing a certain amount and figuring out later how the money is going to get there.