Thursday, July 26, 2012

Is Your 401K A Lawsuit Waiting to Happen? What Employers and Employees Must Do NOW

If you’re an employer offering a 401K plan to employees, it’s time to review what you bought—especially if it’s been over 5 years. And, if you’re a well-intentioned employee, putting a certain amount away to plan for retirement, you are entitled, as of July 1, to know exactly how much and where administrative fees are charged by your plan provider. The news of ABB’s recent fine, over $35 million dollars, came as a result of their failure to produce rebates from the investment companies acting as retirement plan providers, including Fidelity. Retirement planning should not be a game of Russian roulette for participants nor should it be for the plan sponsor.
“Suppose a 31-physician practice had a retirement plan with a typical annuity offering inside of the 401K. It would have around $8.4 million and cover an income range from $45,000 to $1.5 million annually. A detailed analysis could uncover several excess costs, “A few key changes would mean this practice could save around $58,800 per year in fees. Not small change—especially when you consider the ramifications of paying excessive fees over time as well as new regulations.”
Any employer, considered the plan sponsor, is legally bound, by fiduciary responsibility, to disclose all fees and adhere to the new ERISA section 408(b)(2) regulations which require confirmation of vendors’ fees as “reasonable.” By its July 1, 2012 deadline, all “covered service providers” were to present the newly required fee disclosures. Now that the date has passed, retirement plan fiduciaries MUST be in compliance with the new regulations, as outlined by the Department of Labor. For business owners who have not provided comprehensive fee disclosures to participants, who are not ERISA compliant, there may a lawsuit waiting to happen.
By the end of August 2012, according to the new regulations from the Department of Labor, service providers must disclose earnings (i.e. fees) that exceed more than $1,000. This means participants will see accurate breakdowns of their costs. Richard Glass writes, “For a fee to be reasonable, the participants also must derive sufficient value from the products and/or services they are buying. Thus, the real question is: What value should the participants be getting for the fees they pay?”
This is a vital question that employers and participants alike should be asking themselves. Several recommendations on what immediate actions to take to be compliant with new and forthcoming regulations:

  •     Plan sponsors must communicate clearly with plan providers to reveal fee structures to employees and provide 100% transparency.
  •     Fiduciary responsibility is in the hands of the plan sponsor and cannot be abdicated.
According to the Department of Labor, “Attorneys, accountants, and actuaries generally are not fiduciaries when acting solely in their professional capacities. . . However, when an employer or someone hired by the employer takes steps to implement these decisions, that person is a fiduciary.” This means employers always retain a level of fiduciary responsibility with all plan provider partners and vendors and must act accordingly.
  •     Independent fiduciary consultants are available. They can change—and more importantly—clarify the specific aspects of fiduciary responsibility which will dramatically lessen the burden of liability.
Finally, be aware that there are many circumstances and definitions that as of now are open to legal interpretation. A formal retirement plan analysis and audit not only evaluates losses and gains, but, creates clarity and legal compliance for all parties: plan sponsor, plan provider, and employee

Wednesday, July 25, 2012

2012 Tax Benefits and Inflation Adjustments.

The value of personal exemptions increases to $3,800 per person and the standard deduction also rises to $5,950 for singles and $11,900 for married couples filing joint returns. Just over 2/3 of taxpayers take the standard deduction, so these year over year increases, however slight, are still important. The tax brackets (10%,15%,25%, 28%, 33%, 35%) remain unchanged, but the transition from one to the next shifts up slightly. For example, the single earner will see the 25% rate start at a taxable $35,350 in 2012 versus $34,500 in 2011. A bit of savings due to inflation adjusted brackets.

The “Kiddie Tax” remains unchanged. A child with unearned income of up to $1900 may be able to take a $950 standard deduction and they will be taxed at the 10% tax rate. Income beyond that may be taxed at the parents’ rate.
Retirement Savings
Contribution limits rose for 401(k), 403(b), and 457 plans as well as the Thrift Savings Plan. The new limit in 2012 is $17,000 plus an extra $5,500 if you are 50 or older by the end of the year. The IRA limit remains at $5,000 or $6,000 if 50 or older.
The HSA (Health Savings Account) contribution limit has increased to $3,100 for individuals and $6,250 for families. An additional $1,000 is available for those 55 and older.
There are no changes this year to the Dependent Care Account.  There is a $5,000 limit for money you and your spouse can withhold pre-tax to pay child care expenses for your child under age 13.
Flexible Spending Accounts will also see no change in 2012. This is pretax money you have withheld in order to pay for medical needs, including co-pays or prescriptions not covered by your plan. There is currently no limit, although most employers have a $5000 maximum permitted. If you have been debating about getting any elective medical procedures you may want to make the most of your flexible spending account in 2012 since the rules will change in 2013 and the maximum you will be able to contribute to an FSA will be limited to $2,500 per year.
In 2012 the Adoption Tax Credit decreases to $12,650. Also note, in 2011, it was refundable, meaning you’d get it if you qualified, regardless of your total tax bill. In 2012, the tax credit can not create a negative tax bill, it can only offset your taxes due for the year.
Child Tax Credit – In 2012 you can still take advantage of this tax credit and reduce your tax liability by up to $1,000 for each qualifying child under 17.  The Child Tax Credit is scheduled to expire at the end of 2012.  If the same tax credit is not extended after 2012, the Child Tax Credit may decrease to $500 in 2013.
Earned Income Tax Credit – This tax credit increased to a maximum $5,891 in 2012, up $140 from last year. The maximum income to receive any of this credit is $50,270, and the credit itself is based on both income and number of dependents in your family. Note – Your investment income must be under $3,200 to qualify for this credit so plan accordingly.
The Saver’s Credit – This is a credit up to $2000 for couples and $1000 if you’re single. To qualify, a couple may have an income of up to $28,750 for a single filer, and $57,500 for married filing jointly. This credit is based on both income and your deposit to a retirement account.
Estate Tax
The estate tax top rate will stay at 35%, with the exemption rising to $5,120,000 until the end of 2012.

Sunday, July 22, 2012

When Should I Take Social Security?-- A 'Simple' Formula


Some 78 million baby boomers are poised to make one of their most important financial decisions of their lives, namely when to take Social Security benefits.  Deciding is no picnic. As my recent column indicated, Social Security’s provisions are unbelievably complicated.
So, this morning, I said to myself, “Gee, I have a lot of knowledge about this issue based on helping to develop my company’s Social Security maximization software program (   Not everyone is going to want to shell out $40 (or $200 in the case of financial planners) to buy the program.  Maybe it would help people if I just wrote down the formula for determining their total benefit.”
This is what I’ve done below.  We don’t use this formula, per se, in our program, so this is the first time I or, I believe, anyone else has actually ever written down the formula.
I’ve focused on the benefit to married couples when both are alive. I’m leaving out child benefits and mother and father benefits.  I’m assuming both spouses are alive between ages 62 and 70, so I’m ignoring survivor benefits.   I’m also ignoring the extremely complex issue of how the particular days and months at which one starts collecting spousal and retirement benefits affect the benefit formula.   Finally, I’m omitting the option that workers have to start collecting retirement benefits, suspend their retirement benefits at or after their full retirement age, and restart their benefits at a higher level at or before age 70.
Below you’ll see the formula for each spouse’s total (retiree plus spousal) benefit, B(a), when she/her is age a.
 After you’ve examined this formula — with its 10 functions, one of which is four dimensional, and the complicated restrictions on the arguments of some of the functions — and turned pale, ask yourself whether it makes sense for our basic saving system – Social Security, on which most retirees depend for virtually all or most of their old age income — to be so complicated that not one in a million Americans is able to correctly decipher it.
If, after perusing the formula, you agree we need to fix the system from the bottom up, at least for young people, please endorse The Purple Social Security Plan.
 And whether or not you like my alternative system, please send a link to this column to your members of Congress and ask them: “Did you design this?  Do you have any idea what you and former members of Congress have constructed here?  Can you understand this formula?  Is this something you expect me to master on my own?  Isn’t it time to make Social Security not only financially sound (it’s 31 percent underfunded, i.e., desperately broke as described in my prior column) but also minimally user friendly?
The “Simple” Social Security Benefits Formula
 There are two pieces to the formula, which I’ll reference as applying to Kate, whose spouse is Frank.  The first piece refers to Kate’s retirement benefit, which is based on her own earnings record. The second piece refers to Kate’s spousal benefit based on Frank’s earnings record.
                    B(a) = PIA(a) x (1 – e(n)) x (1 + d(n)) x Z(a) + max(.5 x PIA*(a) – PIA(a) x (1+d(n))) x E(a), 0) x (1- u(a,q,n,m)) x D(a)

Here’s the notation:
B(a) is Kate’s benefit at age a.
PIA(a) is Kate’s Primary Insurance Amount (her full retirement benefit) at age a.  Note, PIA(a)  can change as Kate ages due to the Re-Computation of Benefits if Kate works beyond age n.
n is the age at which Kate starts collecting her retirement benefit.  If q is greater than or equal to m and m is less than n*, n = q.
n* is Kate’s full retirement age, assumed to be 66.
m is Kate’s age when Frank first collects his retirement benefit or files for retirement benefits but suspends their collection.
q is the age that Kate applies for or is deemed to apply for spousal benefit.
e(n) is Kate’s Early Retirement Reduction factor.  It ranges from .25 to 0 as n ranges from age 62 to 66 (Kate’s assumed full retirement age).  For n to be positive it must be less than n*.
d(n) is the Delayed Retirement Credit factor.  It ranges from 1 to 1.32 as n ranges from 66 to 70.
Z(a) is a dummy variable, which equals 0 if Kate is not collecting her retirement benefit in year a, i.e., if a is less than n.  Its value is 1 if Kate is collecting her retirement benefit, i.e., if a equals or exceeds n.
PIA*(a) is Frank’s Primary Insurance Amount when Kate is age a.
D(a) is a dummy variable, which equals 1 when Kate is age a if Frank is either collecting his retirement benefit or has filed for his retirement benefit, but suspended its collection.   Otherwise D(a) equals 0.
E(a) is a dummy variable, which equals 0 in year a if Kate has, as of year a, neither started collecting her retirement benefit nor filed for and suspended her retirement benefit’s collection.  When D(a) equals 1, E(a) will equal 1.  But E(a) can also equal 1 when D(a) is 0 if Kate has filed for and suspended the receipt of her retirement benefit.
u(a,q,n,m) is the Spousal Benefit Reduction factor.   It ranges from 0 to .30.  If both m and n are less than or equal to n*, q = max(n,m).  For u(a,q,n,m) to be positive, a must equal or exceed  q.
The first part of the formula determining Kate’s own retirement benefit, is easier than the second.  It says that Kate’s retirement benefit is anchored by her Primary Insurance Amount, which is itself determined by a formula based on the average of Kate’s 35 highest past covered earnings adjusted for economy-wide real wage growth.  Kate’s PIA is then zapped or increased based on the early retirement and delayed retired factors, e(n) and d(n), respectively.  But for Kate to receive a benefit, she has to apply for one.  That’s governed by the Z(a) factor.
The second part of the formula refers to Kate’s spousal benefit.   For Kate to be able to collect a spousal benefit on Frank’s account, Frank has to be either collecting his retirement benefit or have filed for it and suspended its collection, i.e., the final term on the right, D(a), must be 1, not 0.  The spousal benefit reduction factor, u(a,q,n,m), is, itself, a pretty complicated object.   For example, if q is less than m, the factor equals zero.  But if n equals or exceeds m and is less than n*, u(a,q,n,m) exceeds zero.
The term E(a) is important because Kate’s spousal benefit is not docked based on her own retirement benefit if she isn’t collecting a retirement benefit or hasn’t filed for her retirement benefit and suspended its collection.   Finally, we have the max function, which takes the maximum value of (.5 x PIA*(a) – PIA(a) x E(a) and zero.