State Pension Debate: Black, White & A Whole Lot of Grey

It comes as almost no surprise that states governments are getting hit in their pocketbooks throughout the recession just as everyone else is.  The difference is, state governments often have a lot more people that they need to write checks to.  One of these checks that has been given a lot of attention lately is the retirement plans for government workers, and it’s no secret that state and local governments are looking for ways to reduce the number the write in the dollar amount section.


According to statistics from The National Conference of State Legislatures, 43 states have changed their retirement plans since 2009 in hopes of finding that ever elusive balance for their budget.  Many states have taken different approaches to that task, implementing plans that increase the amount of money that workers contribute to their retirement, increasing the age in which benefits can be reaped and more.  These changes have put a bad taste in the mouths of most public employees who have stood behind the shield of laws that protect their pensions as these battles continue to fill our courtrooms with various appeals and challenges.


It’s a messy issue that is causing upheaval in nearly every state, flooding local news outlets with protests, sit ins and even a Governor’s recall election or two.  Like any heavily involved controversy, it isn’t black and white.  The shades of grey hovering over this issue are more numerous than many people realize, or want to try wrap their heads around.

First of all, many of the changes (or proposed changes) do not have any effect on current workers who have spent their lives in a job planning for the benefits to come after retirement.  Most people accepted government jobs, many times with lower pay than the private sector, because of the shining light of their pensions at the end of the long tunnel of employment.  Of course, there are a few states, such as Louisiana and Florida, which are asking (or in other words, are attempting to make a state law requiring) current employees to contribute more to their retirement funds but these laws are facing the most stiff defense from labor groups and unions.  With the exception of a few cases, the changes in pension policies will affect only those who are hired after the legislation passes.

Something else that most private sector employees don’t take into account in these battles is the soft little pillow we like to call Social Security.  Many employees who are covered by a public retirement pension program, a program that they are now at risk of losing, are not covered by Social Security.  When the Social Security system was created it didn’t include any public sector employees.  This changed after many states made what are called “Section 218 agreements” with the Social Security Administration to give their employees some coverage under the federal program.  Later, a 1991 federal law gave Social Security coverage to any public employee that weren’t involved in the Section 218 agreements or didn’t have pension programs through their agency.  So although times have changed, many employees rely on their pension programs to fill in for their lack of Social Security benefits.  They don’t have the safety net waiting to catch them in the end, because they have spent their lives in a system that was supposed to replace that.


One aspect of this controversy that seems to be the most transparent, but most obvious shade of grey is the simple fact that state governments are, at their roots, a business.  When private sector businesses can’t cover the expense of their employees, they cut costs, lay people off, or in the worst cases, go out of business.  Well state governments can’t shut down, for obvious reasons.  They can’t fire all their workers, again, for obvious reasons.  Their only choice is to cut costs.  Like any business, state and local governments have a balance sheet, with liabilities and assets, and there are new accounting rules which will change how those will be calculated.  With many states lacking the assets needed to cover their employee retirement programs, some missing over 70% of the necessary funds, they are not looking very valuable to Mr. Moody and his ratings for investors.  If states can’t find a way to cut their deficit, many investors will begin to expect a higher yield to make up for the higher risk and lower ratings, which will add further costs to the government.  With all of the emotions involved in the fiery battles around the nation, the bottom line for many states is simply, “It’s not personal, it’s business.”


Overall, the battle over state pensions involves both the worker’s money and their future and there are few things life that people fight harder to protect than that.  The problem is that the states are fighting for the same two things.  This dispute over worker pensions is a sea of grey in a dizzying world of passionate black and white.  Round and round with the issues we go, where we will stop, nobody knows.

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Roth 401(k)s vs. Traditional 401(k)s

By now, most Americans understand that at the very least, they should be participating in their employer’s defined contribution plan, most commonly offered in the form of a 401(k). But some companies offer two forms of these plans: the traditional 401(k) and the Roth 401(k). You thought deciding how much to allocate to your plan and then researching and electing the investment funds to support it was confusing enough, but here you are, faced with yet another option for safeguarding some retirement funds. Let’s break it down just a bit more.

What’s the difference?
The primary difference between a traditional and a Roth 401(k) is simple but significant. With a traditional 401(k) plan, your contributions grow tax free, and you pay taxes on the withdrawals; Roth 401(k)s, on the other hand, work in precisely the opposite way, as you pay taxes on your contributions but not on your withdrawals.

Additionally, Roth 401(k)s tend to be seen as more of an estate planning tool, since they do not necessitate that you to take required minimum withdrawals (RMDs) once you reach age 70 ½, as you must do with traditional 401(k)s. This allows you to leave your funds untouched for as long as you want after retirement, letting your investment grow tax free all the while.

Which is right for you?
This is a conversation best held with your financial advisor, as you must determine whether the back-end payoff of a Roth 401(k) outweighs the benefits of traditional tax deferral on the front end, but generally speaking, it depends largely on where you are in life and into which tax bracket you fall.

If you’re relatively young with an eye toward saving for retirement and you don’t earn a great deal of money, a Roth 401(k) may be worth exploring, as the upfront tax-savings benefits wouldn’t be as significant to you as a tax-free payout in retirement. Conversely, if you’re an established earner in a higher tax bracket, getting up-front tax-advantaged treatment is probably best, making the traditional 401(k) your most likely option. This is especially true for individuals who expect to be in a significantly lower tax bracket when they retire.

You can even double-dip.
If your employer does offer both types of 401(k) plan, you can split your contributions between the two if you so choose, as long as your  combined annual contributions do not exceed 2012’s annual limit of $17,000. If you’re 55 or older, that limit jumps to $22,500.

With so many options, there is a 401(k) plan, or a combination of the two, that is ideal for your current situation. But before you make your decisions, be sure to weigh these considerations carefully, especially if you don’t speak with a financial advisor regularly.

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What is a 401K?

Of course you’ve heard of a 401k, but what exactly is it, and how do you manage one successfully?  401k plans are an excellent addition to your retirement planning and serve as a dual-feeding investment between you and your employer.  And even though there is an equal monetary deposit between both you and your employer, there are other aspects of the 401k plan that may or may not bode well for your financial plan.  In the very least, we will break down the nuts and bolts behind the 401k and give you the tools you need to decide whether it is right for you.

First and foremost, what is a 401k, and how does it work?  401k plans are retirement savings plans sponsored by your employer.  It allows employees to invest and save a portion of their paycheck before taxes are deducted.  Taxes are then taken out once the money is removed from the account.  With a 401k, you decide how your money is invested.  Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be a combination of stocks and bonds, which gradually become more moderate as you reach retirement.

Next comes the question of how much you should invest.  If your employer is matching your timely investment percentage each paycheck it would benefit you greatly to keep your 401k contribution at a feasible amount.  Obviously, manage your finances and ensure that you have enough to live and enjoy life, but keep in mind that retirement planning is important.  If your employer is offering a 50-50 contribution you should take advantage of the plan; don’t leave cash on the table.  The most popular contribution is 3% of your salary.  So, if you earn $50,000 a year and contribute 3%, your personal contribution will be $1,500 and your company’s contribution will be $1,500.  Although you can contribute over 3%, your company cannot, and this is where the possible drawbacks begin.

The IRS mandates contribution limits for 401k accounts.  As noted, your company will not contribute over 3%, and the total dollar amount that can be contributed—including both your contributions and your employers’—cannot exceed 100% of your salary.  In most cases, you can’t tap into your employer’s contributions immediately.  There are complex rules about when you can withdraw your money and costly penalties for pulling funds out before retirement age.  This is why most employers hire investment administrators to oversee your account.  It is their job to inform you of updates about your plan and its performance, manage the paperwork and assist you with requests.  You can also go to your administrator’s web site or call their help center if you need further assistance.

The final question is which type of 401k you should invest in.  Most companies offer a traditional 401k, where the less common plan is a Roth 401k.

Traditional 401k:

  • Wages are contributed before taxes from each paycheck, like a deferred salary.
  • Taxable income drops by the amount you contribute.
  • You pay income taxes on contributions and earnings upon withdrawal.
  • No access to your funds before age 59 ½ or if you leave your employer at age 55 or older.
  • If you dip in early, expect a 10% penalty — on top of the usual tax bill.

Roth 401k:

  • Contributions are made with money that’s already been taxed.
  • No taxes paid upon withdrawal.
  • Better flexibility: free access to your money as long as you’ve held the account for 5 years.

As you can see, there are benefits and drawbacks to both 401k retirement plans.  It is essential to survey your finances and what types of savings plans are right for you.  401k plans are great because of the contributions made by your employer, and the flexibility of deciding how much you’d like to contribute.  Don’t hesitate to ask if you have any further questions or comments regarding 401k plans or financial management in general.


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Give Your Retirement Plan an Annual Checkup

Just like your annual physical to protect your health your company retirement needs an annual checkup. Regulations are in a constant state of flux, plus there are advancements within the industry. Remember the 401k is becoming the sole source of retirement for most Americans and should be offered as such.

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Regular Plan MaintenanceIn addition to conducting an annual plan review, plan sponsors should perform regular maintenance to ensure seamless plan operations. This includes staying current on regulations, watching out for common mistakes and reporting to the federal government as required. Plan sponsors are responsible for establishing a program of internal controls, including monitoring and oversight controls surrounding the retirement plan.

A retirement plan committee can help the monitoring and oversight function. However, the committee won’t be effective unless it conducts regular meetings. These oversight meetings should not only review investment results but also check that internal controls related to plan administration are effective and operating appropriately to assist in identifying and detecting operational failures. The retirement plan committee should be well versed in all aspects of the plan, including review of investment performance, keeping current on law changes and monitoring of third-party administrators.

Employers where hiring an ERISA 3(38) Investment Manager does not work, the establishment of a retirement plan committee is recommended. Be certain that this committee meet regularly and documents all meetings. This is necessary in the event of an IRS audit.

Please comment or call to discuss this process.

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Small business owners are unprepared for retirement

A disciplined savings and investing strategy is much easier than most small business owners believe. By installing a retirement plan for themselves and their employees they will save in taxes and help their employees. The benefit to employees will result in increased loyalty and satisfaction.

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“The lack of retirement planning by so many people is stunning, especially since business owners have no one else to rely on when it comes to putting their retirement plans in place,” says Mary Quist-Newins, director of the State Farm Center for Women and Financial Services at The American College. “When you consider that the mean age of our respondents is just over 50 you have to wonder, ‘What are these individuals waiting for?’ Retirement will be upon them before they know it. Small businessowners need to start preparing for retirement now.”Even for the small business owners who have calculated their retirement goals, most do not have a formal plan to achieve their financial objectives. Among the small business owners surveyed, 77% of the women and 74% of the men have no written plan for retirement.

Small business owners are far too busy running their business to take the time to properly plan and execute a strategy to successfully retire. Many wait until three years or less before retirement to plan. Others believe they will sell their business to fund their retirement. This lack of planning forces many to make decisions they would not ordinarily do.

Please comment or call to discuss what it takes to begin a retirement plan.

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The 4 Critical Elements of a Successful 401k Plan Education Program

Without proper knowledge everyone will make emotional and usually imprudent decisions with their money. Investing for retirement requires participants to acquire the right information to develop a prudent strategy. Investors don’t have to know everything about investing but they do need to know the right things.
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  • Consistent and Regular – This means the terminology used in all plan literature is consistent with the terminology used in the education program. If the plan’s education program talks about goals in terms of the modern investment objectives, then the plan’s web-site cannot continue to refer to the traditional investment objectives. (If you’re unfamiliar with the difference between the two, read “401k Plan Sponsors: Is Your Investment Policy Statement Still Using Outdated Language?, May 17, 2011.) Similarly, an education program should be a regularly event and scheduled at a convenient time for employees.
  • Tied to Investment Policy Statement – An IPS that can’t be understandably articulated to employees through education is not worth its salt. Likewise, a well-drafted IPS that isn’t understandably articulated to employees through education is not worth its salt. The IPS drives the investment philosophy of the plan and should also provide a handy blueprint for a successful education program. (For those interested in learning more, read “How Should a 401k Plan Sponsor Construct an Appropriate Investment Policy Statement?, June 7, 2011.)
  • Covers both Administration and InvestmentsSure, the quarterback gets to do all the commercials, but he wouldn’t be where he is if it weren’t for his linemen. Similarly, everyone always wants to talk about investments, but the problems 401k plan participants face aren’t due to a lack of good long-term investments, they’re mainly due to inadequate savings. The mechanics of savings begins with understanding the administrative functions of the plan and carries through how participants determine their broad investment strategy.
  • Customized to the Plan’s EmployeesMany investment professionals once thought the need to understand plan demographics disappeared as we migrated from pension and traditional profit sharing plans to participant directed 401k plans. That can’t be farther from the truth. Not only do we need an array of investment options geared to people of different ages and different economic backgrounds, but the plan’s education program needs to address the different learning styles of the different generations.

Retirement plan education may be the key element to a successful plan. When employees are engaged and informed they will be more comfortable with saving and investing. It may be more of a matter of coaching. Providing the right principles and remaining disciplined to a scientific designed strategy.

Please comment or call to discuss how your plan can be improved through a proper education program.

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Corporate Pension Pain Mounts

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The retirement fund crisis in the public sector will determine how employees in the private sector save and invest for retirement. This crisis should teach everyone that you cannot rely on the government for your financial future. More and more companies are freezing their pension plans. This will put more focus on the 401(k) plans and how they are offered. Americans must begin a disciplined approach to saving for their own future.

Companies from defense contractor Lockheed Martin Corp. to aviation-electronics maker Honeywell International Inc. are caught in a vise: the Federal Reserve Board’s vow to keep rates at current levels until 2014 means pension plans’ fixed-income investments are stagnating just as new rules shorten the time available to shore up funding.“They’re going to have to kick money in,” said John Ehrhardt, a consulting actuary at Seattle-based Milliman. “We’re basically seeing historically low interest rates driving historically high employer contribution requirements.”

That’s money that won’t go back to shareholders through dividends or buybacks, or toward expansion, said Kevin McLaughlin, a pension risk management specialist with consultant Mercer in New York.

Under the federal Pension Protection Act, which was passed in 2006 and mostly took effect in 2008, tighter accounting rules gave employers seven years to fully fund their retirement plans and required them to use a specified, market-based rate of return to compute liabilities instead of a company estimate.

The decline in the number of firms offering a pension plan will continue. The result of this is more focus on the importance of the 401(k) plan as a retirement savings vehicle. The 401(k) plan of tomorrow will have a more pension fund like feel. This means model portfolios and less options. Leave the investment choice and strategy to professionals.

Please comment or call to discuss how this can affect you and your organization.

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American Workers Seek More Security in Retirement and Health Plans

With the decline in pension plans expected to continue. Companies that seek to remain competitive for talented employees must provide excellent employee benefits. This includes a 401(k) plan that looks more like a pension plan but without all the risk for the employer. MOst plan participnats realize that they cannot beat the market. These employees are looking for guidance from their employers. Those employers providing the proper guidance will be rewarded with talented and loyal employees.

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Retirement security has become more important to many employees

The economic and financial crises over the last three years unveiled a retirement savings crisis long in the making. While Social Security’s shortfalls are a perennial worry, recent steep declines in 401(k) accounts — in some cases combined with inadequate savings over a longer period — and falling housing prices have forced many workers to shelve their dreams of a comfortable retirement, at least temporarily.

Since the economic crisis, nearly two-thirds of survey respondents have been paying closer attention to their retirement readiness. This is particularly true of older workers, DB plan participants and higher-income workers. Over the last three years, retirement security has taken on greater priority for nearly nine in 10 older workers

Business owners/managers will need to focus more on the quality of the retirement plan they offer to employees to attract and retain talented people. A great way to address this is to hire an independent fiduciary to a manage their company retirement plan. This will improve results and reduce anxiety.

Please comment or call to discuss how this affects you and your company.

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BofA to Freeze Pension Fund

As more and more companies from a pension plan to a 401(k) plan exclusively the quality in a 401(k) must be improved. The current model of the 401(k) is that of a supplement to a pension plan. This must change to ensure Americans will be able to successfully retire. Most business owners are far too busy running their comapny with little time to manage a retirement plan for employees and themselves. This is why most should hire a professional fiduciary.

According to news reports, employees will keep the pension benefits they have earned to date; however, workers will no longer accumulate new benefits into the fund.The company is moving to a 401(k) retirement plan for most of its employees. The company currently matches contributions of eligible workers up to 5% in the 401(k) plan; however, starting on July 1, the company will start contributing funds into workers’ 401(k) plans, regardless of whether they contribute to the plan. The company will contribute 2% to 3% of a worker’s salary into the 401(k) plan.

This is additional evidence that the 401(k) plan is no longer a supplement to a pension plan but rather the sole source of retirement for most Americans.

Please comment or call to discuss how this will affect you and your company retirement plan.

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