All Nerd's Eye View Articles On Retirement Planning

IRS Notice 2015-49 Cracks Down On Accelerated Lump Sum Pension Buyout Offers

October 7, 2015 07:01 am 15 Comments CATEGORY: Retirement Planning

In recent years, pension plans and their employer sponsors looking to “de-risk” their exposure have been increasingly offering “lump sum pension buyout” offers to employees, where a pensioner receiving ongoing payments has the opportunity to convert the remaining expected payments to a one-time lump sum that can be rolled over to an IRA.

Yet while the conversion of a lump sum to a pension isn’t always a bad deal – at least if the lump sum is ‘reasonably’ valued – in practice the lump sum offers have been so ‘modest’ that even a recent non-partisan GAO study raised the concern that participants may not be getting enough information (and therefore may not be making the right decision) when the offer comes.

Accordingly, the Treasury has announced plans to issue an updated version of Treasury Regulation 1.401(a)(9)-6, Q&A-13 and Q&A-14, that will limit the ability of pension plans to offer lump sum pension buyout offers to those receiving ongoing payments. And the IRS announced in IRS Notice 2015-49 that the new rules will be effective retroactively back to July 9^th of 2015, rendering lump sum buyout offers dead, effective immediately.

Notably, the crackdown on the employee pension buyout offer will not limit the ability to choose a lump sum versus a pension at the time of retirement, but it will prevent those from receiving ongoing pension payments from commuting those payments into a lump sum. For most, that’s probably good news, given ‘questionable’ buyout offers (and Congress beginning to scrutinize various "pension advance" schemes), and concerns about the ability of some retirees to manage the investment and longevity risk that they take on with a lump sum. However, for those in poor health or who fear their underfunded defined benefit plan may default (and don’t want to rely on PBGC backing), the new rules have taken a potential buyout offer off the table. And ironically, while the purpose of the new rules was to shore up protections for pensioners, the elimination of yet another means by which plan sponsors can “de-risk” their pension exposures may only serve to further accelerate the slow-motion demise of the defined benefit plan altogether.

Why A QLAC In An IRA Is A Terrible Way To Defer The Required Minimum Distribution (RMD) Obligation

September 23, 2015 07:01 am 61 Comments CATEGORY: Retirement Planning

The longevity annuity has become increasingly popular in recent years as a potential new vehicle for retirement income, as its ability to delay payments to an advanced age like 85 allows for a significant accumulation of mortality credits. And since the introduction of last year’s Treasury Regulations, a so-called “Qualified Longevity Annuity Contract” (QLAC) can even be purchased inside of an IRA or other retirement account, allowing a portion of a retiree’s RMDs to be deferred from 70 ½ to as late as age 85!

However, as it turns out the unique nature of a longevity annuity’s payment structure is not very hospitable as an RMD deferral strategy. The fact that it can take until a retiree’s late 80s just to break even and recover principal means the retiree risks significant foregone growth by trying to merely defer RMDs through the use of a QLAC. And of course, the RMDs will still eventually happen anyway, as the QLAC merely defers when payments begin. In fact, ironically, if the retiree does live, the accelerated payments of a QLAC in the later years can actually deplete an IRA even faster than normal IRA RMDs would have anyway!

Ultimately, this doesn’t mean that the longevity annuity (or a QLAC inside an IRA) is a bad deal. The ability to accumulate mortality credits still means it can be very effective as a fixed income alternative for those who fear they may not have enough money to fund a retirement well beyond their life expectancy. And if retiree intends to spend all of his/her assets anyway, and the only available dollars for retirement are held in an IRA or other retirement account, the QLAC is an effective means to engage in such a strategy. Nonetheless, the bottom line is that while a QLAC may be a valid way to use a retirement account to hedge against longevity – and defer RMDs along the way – it’s still not very effective as an RMD avoidance or deferral strategy! Just because you can buy a longevity annuity inside a retirement account as a QLAC doesn't mean you should!

Social Security And Medicare Claiming Strategies To Navigate The Looming 52% Medicare Part B Premium Spike

August 26, 2015 07:01 am 43 Comments CATEGORY: Retirement Planning

Under Social Security and Medicare rules, the “Hold Harmless” provision is a special rule intended to protect most Social Security recipients from experiencing a decrease in their (net) benefit payments, by limiting the (dollar) amount of the annual Medicare Part B premium increase to the (dollar amount) of Social Security’s cost-of-living adjustment. And due to negative inflation from the recent fall in energy prices, the 2016 Social Security COLA is on tracked to be “floored’ at the minimum 0.0%, which in turn means that Medicare Part B premiums will be locked in for a 0.0% increase in 2016.

However, the "Hold Harmless" provisions only apply to approximately 70% of currently Medicare enrollees for the protection. Which means that the entire magnitude of Medicare's rising costs must be borne by just the other 30% of Medicare enrollees, as well as any who planned to enroll in 2016, resulting in a project 52% spike in Part B premiums next year!

Given the looming Medicare Part B premium increase, those who are not eligible for the Hold Harmless provision - for instance, those enrolled in Medicare but delaying Social Security benefits, or those who haven't yet enrolled in either but could - should carefully consider whether it is really still worth delaying Social Security benefits (and/or delaying enrollment in Medicare), given that those who begin the process by October of this year still have the potential to get started in time to be eligible for Hold Harmless and shelter themselves from the 2016 increase.

And in practice, it appears that slightly accelerating claiming may in fact be appealing, especially for those who otherwise anticipated starting Social Security and Medicare Part B in 2016. On the other hand, higher-income taxpayers who are subject to the Medicare Part B premium surcharge cannot protect themselves (or do anything else about it, since the calculation would be based on income from 2014 and that tax year is long since closed). And for those who still plan to delay Social Security benefits for many years to come, the reality is that delaying Social Security benefits is still so valuable, that even the projected Medicare Part B premium spike is still not nearly enough to deter the long-term value of generating Social Security’s Delayed Retirement Credits for those who anticipate living well past the breakeven period.

How The Medicare “Hold Harmless” Rules May Spike Part B Premiums By 52% In 2016

August 19, 2015 07:01 am 62 Comments CATEGORY: Retirement Planning

For virtually all retirees, Medicare is the core means by which health insurance is obtained in retirement. Coverage is provided via a combination of Medicare Part A (for hospital insurance) that is free, plus Part B (for medical insurance covering doctor’s visits, outpatient procedures, and more) for a subsidized premium, and Part D (for prescription drugs) also paid via a separate premium. Together, the Medicare system goes a long way to stabilizing the unknown of health care costs in retirement into a series of known health insurance premiums.

For most retirees, the Medicare Part B (and potentially Part D) premiums are simply subtracted directly from ongoing Social Security benefits payments, and each (Social Security benefits and Medicare premiums) have their own inflation adjustments each year (with Medicare healthcare inflation higher than general inflation adjustments most years).

Notably, though, the Social Security system also includes two key provisions to help smooth cash flows for retirees. The first stipulates that if inflation is negative, the Social Security Cost-Of-Living Adjustment (COLA) can never be negative; at worst, the Social Security COLA has a floor of 0.0%. The second provision, often dubbed the “Hold Harmless” rule, and applicable to as many as 70% - 75% of Medicare enrollees, states that Social Security benefits payments cannot decrease due to rising Medicare Part B premiums; at worst, the Medicare premium increase is capped at the dollar amount of the Social Security COLA increase.

Except in the coming 2016 year, when the Social Security COLA is projected to be 0.0%, the combination of these two rules means that none of the coming year’s Medicare Part B premium increase can be applied to the 70%+ of Medicare enrollees eligible for the Hold Harmless provision… which means all of the increase must instead be borne by the roughly 25% of Medicare enrollees not subject to the “Hold Harmless” provision. As a result, unless the Secretary of Health and Human Services Department intervenes by October, based on current projections the Hold Harmless provision may result in a spike in Medicare Part B premiums by as much as 52% (or over $600 per person) for those not protected by the rule!

How Has The 4% Rule Held Up Since The Tech Bubble And The 2008 Financial Crisis?

July 29, 2015 07:01 am 50 Comments CATEGORY: Retirement Planning

The 4% rule has been much maligned lately, as recent market woes of the past 15 years – from the tech crash of 2000 to the global financial crisis of 2008 – have pressured both market returns and the portfolios of retirees.

Yet a deeper look reveals that if a 2008 or even a 2000 retiree had been following the 4% rule since retirement, their portfolios would be no worse off than any of the other "terrible" historical market scenarios that created the 4% rule from retirement years like 1929, 1937, and 1966. To some extent, the portfolio of the modern retiree is buoyed by the (only) modest inflation that has been occurring in recent years, yet even after adjusting for inflation, today’s retirees are not doing any materially worse than other historical bad-market scenarios where the 4% rule worked.

Ultimately, this doesn’t necessarily mean that the coming years won’t turn out to be even worse or that the 4% rule is “sacred”, but it does emphasize just how bad the historical market returns were that created it and just how conservative the 4% rule actually is, and that recent market events like the financial crisis are not an example of the failings of the 4% rule but how robustly it succeeds!

How To Evaluate The Pension Versus Lump Sum Decision, And Strategies For Maximization

July 22, 2015 07:01 am 51 Comments CATEGORY: Retirement Planning

While the use of pensions as an employee benefit is on the decline, many of today’s workers nearing retirement have participated in a pension plan for the past several decades, and have already accumulated a significant pension benefit. And as those individuals begin to retire, they are faced with the classic decision of whether to keep the lifetime pension payments, or choose a lump sum instead.

While there are several factors that go into the pension-vs-lump-sum decision, ultimately the trade-off can be boiled down to calculating the internal rate of return (IRR) of the promised pension cash flows, which reveals the “hurdle rate” of return that a lump sum portfolio would have to earn to generate to reproduce those same payments over the same time horizon. Of course, the longer the retiree is expected to live, the greater the number of anticipated pension payments, and the greater the portfolio hurdle rate will be.

Ultimately, though, because life expectancy will vary by the individual, and in practice the size of a lump sum relative to a pension payments will also vary from one plan to the next (and also over time, as the GATT rate used to discount the pension payments fluctuates from month to month and year to year), the decision of whether to keep a pension or convert it into a lump sum will vary from one person to the next. In some cases, choosing a lump sum will clearly be best (e.g., when life expectancy is short or the hurdle rate is especially low), while in others there will be no way for a portfolio to generate similar cash flows without a significant amount of risk – at least, as long as the pension plan itself remains secure and isn’t facing a potential default or being forced to rely on PBGC backing!

The Ratcheting Safe Withdrawal Rate – A More Dominant Version Of The 4% Rule?

June 3, 2015 07:01 am 53 Comments CATEGORY: Retirement Planning

The fundamental purpose of the so-called “4% rule” is to determine an appropriate “income” or spending floor that is low enough to survive potential sequence-of-return risk – at least, based on the worst return sequences that can be found in the historical data. If market returns going forward turn out to be as bad as scenarios like the Great Depression or the stagflationary 1970s - from which the 4% rule originated - the portfolio is still anticipated to sustain inflation-adjusted spending to the end of the 30-year time horizon. If returns are better, there will simply be “extra” money left over.

Yet the reality is that in the overwhelming majority of scenarios, returns are not so bad as to necessitate a 4% initial withdrawal rate in the first place. In fact, by applying the 4% rule, over 2/3rds of the time the retiree finishes with more than double their wealth at the beginning of retirement, on top of a lifetime of (4% rule) spending! Half the time, wealth is nearly tripled by the end retirement, as retirees fail to spend their upside!

Accordingly, a more dominant approach is to plan in advance that if the portfolio gets “far enough” ahead, spending can be increased - but not increased so quickly that the retiree might have to go backwards shortly thereafter. Of course, the reality is that retirees experiencing a “favorable” sequence of returns will inevitably sit down for a portfolio/retirement review and realize they are so far ahead that it’s “safe” to increase spending anyway. But as it turns out, a relatively simple ratchet-style approach, where spending is increased by 10% any time the portfolio rises more than 50% above its starting value, can “dominate” the traditional 4% rule, generating equivalent or better retirement spending in all scenarios, even while being conservative enough to not require a spending cut in the event of a market pullback in the future.

Proposals For Eliminating Stretch IRAs, Repealing NUA, And The $3.4M Retirement Account Cap In The FY2016 Treasury Greenbook

February 18, 2015 07:01 am 22 Comments CATEGORY: Retirement Planning

Every year, the proposed changes to the tax laws encapsulated in the President’s budget request for the Federal government are recorded in the Treasury Greenbook, which is then taken under advisement by Congress to create its own budget resolution. And while the President’s budget request does not necessarily dictate what Congress will decide to do, it does provide valuable insight into potential legislation that may be considered in the coming months and years.

While some tax proposals in the Greenbook are relatively minor, or pertain to issues not directly relevant to our work as financial planners, this year’s FY2016 budget request had several proposals that would represent major changes in the world of planning for retirement accounts, both during clients’ lives and after they pass away.

Accordingly, following on last week’s review of the “good” and the “bad” of the proposed tax law changes for retirement accounts, we look at some of the “ugly” provisions that could have a more dramatic impact in the coming years, from the possible elimination of stretch IRAs (requiring the 5-year rule for most non-spouse beneficiaries), to a $3.4M “cap” on retirement accounts (though it is actually just a cap on new contributions to retirement accounts), and the proposed repeal of the Net Unrealized Appreciations (NUA) rules for those who were born after 1965!