Nebraska Retirees Ask Lawmakers for Social Security Tax Break

Nebraska

Retirees are telling Nebraska lawmakers that the state’s tax burden is too high, and additional tax cuts may be necessary to keep seniors from fleeing the state during retirement.

One option retirees are pushing: exempting Social Security benefits from the income tax.

A tax package passed last year attempted to shore up some of these issues. From the Grand Island Independent:

Last year’s tax package included a partial [tax] exemption for military retirement pay, but it didn’t apply to those who had already retired before the law went into effect. It also allowed married couples making up to $58,000 a year to have all of their Social Security benefits exempted from Nebraska’s income tax.

But Nebraska retirees said those cuts aren’t enough to keep them from retiring to more tax-friendly states.

Nebraska lawmakers are currently considering three separate bills that would address the tax issue. From the Grand Island Independent:

One measure by [Sen. Paul] Schumacher would provide a tax exemption for earned income of Nebraskans who are at least 65 years old.

Schumacher said the bill would create a financial incentive for retiring baby boomers to stay in the workforce longer rather than retiring, which would help ease the state’s labor shortage. Lifting the tax burden would also help them add to their retirement savings, he said.

Another bill by Sen. Sue Crawford of Bellevue would give tax breaks to military retirees who live in Nebraska while working and earning retirement income. For every dollar those retirees earn from work, one dollar in retirement income would not be taxed. Joint filers could exempt up to $60,000 of their retirement income annually, for up to 15 years.

Sen. Brett Lindstrom of Omaha pitched a bill that would phase out Nebraska’s tax on Social Security income over five years.

The formal names of those bills are: LB63, LB165 and LB26

Actuaries Call on Obama to Address Aging Issues, Retirement Security in State of the Union

capitol

The American Academy of Actuaries is urging President Obama and the U.S. Congress to tackle retirement security issues through public policy over the next two years.

That includes addressing the solvency of Social Security, improving the governance and disclosure requirements of public pension plans, and ensuring adequate retirement income for seniors who are living longer.

From the AAA:

The American Academy of Actuaries is calling on the president and the 114th Congress to commit to a focus in the next two years on addressing the needs of an aging America. A concerted national strategy on policies to support systems such as retirement security and lifetime income, health care and long-term care for the elderly, and public programs such as Social Security and Medicare, is long overdue.

[…]

As President Obama prepares to address Congress and the American people this evening, the Academy (which celebrates its own 50th anniversary this year) would point out that the state of our union is inextricably linked to the demographic transition of proportionately greater numbers of Americans entering retirement, coupled with increased longevity, or life expectancies, that will compound the fiscal challenges to both private systems and public programs in the years to come.

The AAA goes on to provide specific points that comprise a public policy “wish list”:

* Take immediate steps to address solvency concerns of key public programs like Social Security and Medicare to ensure that they are sustainable in light of changing demographics. The Academy also urges action to allow the disability trust fund to continue to pay full scheduled disability benefits during and beyond 2016.

* Evaluate and address the risk of retirement-income systems not providing expected income into old age, especially in light of increasing longevity. The Academy’s Retirement for the AGES initiative provides a framework for evaluating both private and public retirement systems, as well as public policy proposals.

* Encourage the use of lifetime-income solutions for people living longer in retirement. The Academy’s Lifetime Income initiative supports more widespread use of lifetime-income options.

* Improve the governance and disclosures regarding the measurements of the value of public-sector (state/municipal) employee pension plans. The Academy’s Public Pension Plans Actuarial E-Guide provides information on the nature of the risks and the complex issues surrounding these plans.

* Explore solutions to provide for affordable long-term care financing, and address caregiver needs and concerns through public and/or private programs.

* Address the impact of delayed retirement, either voluntary or through future retirement age changes, on benefit programs, as well as the needs it may create with increased demand for early retirement hardship considerations and disability income programs.

Read the full release here.

Chart: Public Workers More Confident in Pensions, 401(k)s Than Social Security, Medicare

retirement confidence graph

A recent survey found that, among all streams of retirement income and benefits, public employees were most confident in their pension and 401(k) benefits; both in terms of being there for them when they retire and being sufficient enough to get them through retirement.

People were least confident in Social Security and Medicare. Only a small portion of people were “very confident” they had enough savings to get them through retirement.

Chart credit: Retirement Confidence Survey 2014

 

Do Pension Plans Give Retirees a False Sense of Retirement Security?

broken piggy bank over pile of one dollar bills

At one time, pensions were seen as the safest, most secure stream of retirement income. But the security of pension benefits is no longer rock-solid. That raises the question: do pensions give retirees a false sense of retirement security?

Economist Allison Schrager explores the idea:

Until recently, a pension benefit seemed as good as money in the bank. Companies or governments set aside money for employees’ retirements; the sponsors were on the hook for funding the promised benefits appropriately. In recent years, it has become clear that most pension plans are falling short, but accrued benefits normally aren’t cut unless the plan, or employer, is on the verge of bankruptcy—high-profile examples include airline and steel companies. Public pension benefits appear even safer, because they are guaranteed by state constitutions.

By comparison, 401(k) and other defined contribution plans seem much less reliable. They require employees to decide, individually, to set aside money for retirement and to invest it appropriately over the course of 30 or so years. Research suggests that people are remarkably bad at both: About 20 percent of eligible employees don’t participate in their 401(k) plan. Those who do save too little, and many choose investments that underperform the market, charge high investment fees, or both.

It turns out that pension plan sponsors, and the politicians who oversee them, are just as fallible as workaday employees. We all prefer to spend more today and deal with the future when it comes. Pension plans have done this for years by promising generous benefits without a clear plan to pay for them. When pressed, they may simply raise their performance expectations or choose more risky investments in search of higher returns. Neither is a legitimate solution. In theory, regulators should keep pension plan sponsors in check. In practice, the rules regulators must enforce tend to indulge, or even encourage, risky behavior.

Because pension plans seem so dependable, workers do in fact depend on them and save less outside their plans. According to the 2013 Survey of Consumer Finances, people between ages 55 and 65 with pensions have, on average, $60,000 in financial assets. Households with other kinds of retirement savings accounts have $160,000. It’s true that defined benefit pensions are worth more than the difference, but not if the benefit is cut.

As the new legislation makes clear, pension plans can kick the can down the road for only so long. Defined contribution plans have their problems, but a tremendous effort has been made to educate workers about the importance of participating. (Even if the education campaign has been the product of asset managers who make money when more people participate, it’s still valuable.) Almost half of 401(k) plans now automatically enroll employees, which has increased participation and encouraged investment in low-cost index funds. And now it looks like a generous 401(k) plan with sensible, low-cost investment options may turn out to be less risky than a poorly managed pension plan, not least of all because workers know exactly what the risks are.

Read the entire column here.

 

Photo by http://401kcalculator.org via Flickr CC License

Are Pensions More Important To Retirement Security Than Data Shows?

Pink Piggy Bank On Top Of A Pile Of One Dollar Bills

Alan L. Gustman, Thomas L. Steinmeier and Nahid Tabatabai have authored a paper exploring the possibility that the importance of pensions, and the financial support they provide retirees, is understated in retirement income data.

The paper, titled “Mismeasurement of Pensions Before and After Retirement”, was published in the Journal of Pension Economics and Finance.

From the paper:

There are a number of reasons why the value of pensions after retirement may be underestimated, especially if evaluation is based on sources of income realized in retirement. First, not all pensions are in pay status, even after the person leaves the pension job. When a pension is not in pay status, it is commonly ignored in questions related to pension incomes. Even when a pension is in pay status, a survey may not include income from the pension. For example, as pointed out by Anguelov, Iams and Purcell (2012), CPS data on pension incomes in retirement count only annuitized income, but not irregular income from pensions, such as periodic withdrawals from 401k accounts. This is an important problem because funds in DC pension accounts often are not claimed until the covered worker reaches age 70, when withdrawals are mandated. Indeed, a disproportionate amount of benefits may not be withdrawn until even later.

The paper provides further reason that survey data may not accurately portray pension benefits received by retirees:

Another factor is that actual benefit payments may be reduced from the pension called for by the simple benefit formula advertised by the firm when an annuity is chosen that differs from the single life annuity emphasized by plan. For example, the annuitized benefit will be reduced when, as required by law, a spouse or survivor benefit is chosen. The reduction will depend on the ages of each spouse and on whether the survivor benefit is half the main benefit, whether it is two thirds as in Social Security, or whether the annual benefit will remain unchanged upon the death of the covered worker. There may be further reductions if the retiree chooses a guaranteed minimum payout period.

To be sure, these differences in payout due to actuarial adjustments do not create actual differences in the present value of benefits. But one must know the details of the respondent’s choice as to spouse and survivor benefits and other characteristics of the annuity, and adjust using appropriate life tables. That is, a proper analysis would not just consider the annual pension payment, but would also consider the value of payments that will be made in future years to the surviving spouse. Typically these details are not available on a survey and no such adjustment is made.

The paper delves much deeper into this issue – read the full paper here.

 

Photo by www.SeniorLiving.Org

Principles For Better Pension Design

talk bubbles

A long, insightful discussion and analysis of pension design was published in the Fall issue of the Rotman International Journal of Pension Management. During the course of the paper the three authors, Thomas van Galen, Theo Kocken, and Stefan Lundbergh, propose a set of principles to help navigate the dilemmas and trade-offs posed by both public and private pension systems.

The paper begins:

Designing a pension system is a complex business in which difficult tradeoffs must be made. On the one hand, we may want everyone to receive a retirement income that is linked to their own contribution; on the other, we want to protect people from poverty. How do we weight these two goals? The choice will depend on societal preferences and cultural values. We must also ask for whom we should design the pension system: what is ideal for a self-employed high-income earner may be far from adequate for someone living on a minimum wage, paying rent, and raising a family of five.

Addressing these dilemmas is a daunting task, especially with the recognition that pension systems all have their own historical background, and that each has evolved in its own particular context.

The authors propose a set of pension design principles, organized into three groups: behavioral principles, stability principles and risk-sharing principles.

The behavioral principles:

1. Keep it simple. Don’t make the pension solution any more complex than necessary. Complexity and lack of transparency make decision making more difficult, increasing the risk that people will make decision they will later regret. Simplicity, by contrast, helps manage people’s expectations and increases their trust, both vital qualities for a successful pension system.

2. Provide sensible choices. Employees should be given a standard package, on top of which a limited set of well- considered alternatives are offered, to protect them from making mistakes while allowing them individual freedom (Boon and Nijboer 2012). Creating a set of choices for a pension system is like drawing up a good restaurant menu: it offers people tools (the menu) for tailoring the solution (the meal) to their needs, but without expecting them to be financial experts (the chef) (Thaler and Benartzi 2004).

3. Under-promise, over-deliver. Research has shown that people experience twice as much pain from a loss as pleasure from a gain of equal size. Therefore, it is wise to avoid delivering outcomes below people’s expectations, which implies that a pension system should offer people a minimum level of pension income that, in practice, will likely be exceeded (Tversky and Kahneman 1992). Research shows that people value some kind of certainty very highly and are willing to pay substantial sums of money for it (Van Els et al. 2004), but too much certainty will make the pension design unaffordable.

The stability principles:

1. Ensure adaptability. Constantly changing external conditions require an adaptable pension system. Explicit individual ownership rights ensure flexibility, so that the system can adjust itself over time, and also make pensions more mobile to move to other systems.

2. Keep it objective. The health of a pension system should be measured based on objective market valuations. An objective diagnosis ensures that beneficiaries feel comfortable with how the pension fund deals with their property rights. If the valuations are calculated differently from market practice, participants may feel they are better off outside the system.

3. Prepare for extreme weather. The world is uncertain and unpredictable things happen; a pension system should be robust under extreme circumstances, built not on predictions but on consequences of possible outcomes. To assess the system’s robustness, draw up a set of “extreme weather” scenarios for risks outside and inside the pension system. The design of the pension system should target the ability to endure these extreme scenarios.

And the risk-sharing principles:

1. Avoid winner/loser outcomes. To avoid losing support, pension system design should prevent any one group of participants benefitting at the cost of another group. For example, if internal pricing in DB plans deviates from market pricing, it is likely to create winner/loser outcomes, eventually leading to pension system distrust.

2. Only diversifiable risks should be shared. A system founded on solidarity in bearing diversifiable risk creates value for all by reducing individual risk. For example, we have no idea how long we will live after we retire, but we can estimate the current average life expectancy of a homogenous group reasonably well, so it makes sense for individuals to pool their individual longevity risk with a large group.

3. Individuals must bear some risks. Risks that cannot be diversified or hedged in the market should be borne by the individual. Pooling non-diversifiable risks leads inevitably to transfers between groups in the collective pool and will eventually erode trust in the system. In reaching for higher long-term returns, younger people can absorb more market risk than older people; this calls not for risk sharing but for age differentiation in exposure to financial markets.

The authors go on to provide examples of these principles in action, using pension systems from the UK, Sweden and the Netherlands. The full seven page paper can be read here.

The Role of Merit in the Career of a Mutual Fund Manager

Graph With Stacks Of Coins

Mutual fund managers hold in their hands the retirement income of millions of people. So it should be of great interest to retirees, and those approaching retirement, whether mutual fund managers are qualified for the job.

A recent study examined 2,846 managers of actively managed mutual to try and answer the question: what is the role of merit in the careers of mutual fund managers?

From the study, which was published in the Financial Analysts Journal:

The results provide evidence of the role of merit in the careers of managers of actively managed funds. Consistent with prior studies, we found that relative performance is an important determinant of career success as a mutual fund manager. We showed that managers who underperform on a style-adjusted basis are at greater risk of losing their jobs.

However, the evidence on the role of superior performance is less strong. Surviving managers of all tenures, even those who lasted 10 or more years, outperformed those with shorter tenures, but we also showed that they did not consistently outperform the market on a risk-adjusted basis or their style benchmark. Data on style-adjusted monthly returns show that solo managers with 10 or more years of tenure outperformed about as often as they underperformed.

When performance is calculated using Carhart or Jensen alphas, even solo managers with tenure of more than 10 years show no ability to beat the market on a risk-adjusted basis. The key to a long career in the mutual fund industry seems to be related more to avoiding underperformance than to achieving superior performance.

The study suggests that, for mutual fund managers, long careers don’t come as a result of consistently outperforming markets, but rather as a result of avoiding under-performance. From the study:

The lack of significantly better performance over time by long-tenure managers suggests that longevity is related to the avoidance of underperformance. Additional factors may be at work in impairing the performance of these managers. For example, researchers have found evidence that some underperforming managers at smaller funds are able to retain their positions despite their performance.

Additionally, other research has shown that a significant proportion of the best mutual fund managers earned their reputations with high rates of return early in their careers and had performance that was significantly worse later on. Whether this early performance was due to luck or early superior skills that atrophied later is subject to conjecture and further research.

The study, authored by Gary E. Porter and Jack W. Trifts, was published in the July/August issue of the Financial Analysts Journal. The entire paper and analysis can be read here.

 

Photo by www.SeniorLiving.Org

Are Affluent Households As Worried About Retirement As Everyone Else?

Retirement sack full of one hundred dollar billsAre affluent households worrying about having enough money to last through retirement? According to a survey from Bank of America, the short answer is “yes” – in fact, it’s one of their biggest concerns.

Bank of America polled 1,000 “affluent” people with investable assets of between $50,000 and $250,000. The results were published in the October issue of Pension Benefits:

“More than half (55%) of the mass affluent (defined as individuals with $50,000 to $250,000 in total household investable assets) fear going broke during retirement-far more common than other stress-inducing pressures such as losing their job (37%).

More women than men (59% versus 51%) are frightened about the possibility of not having enough money throughout retirement, and the fear of an uncertain retirement is also most common among 61% of Gen Xers (aged 35 to 50) and 61% of Boomers (aged 51 to 64). Only 41% of Millennials (aged 18 to 34) feel this way.

Despite their fears about future finances, many mass affluent won’t consider cutting back on indulgences today to save for retirement-from entertainment (33%) to eating out (30%) to vacations (28%).

Even if they were faced with a hypothetical milliondollar windfall, fewer than one in five (19%) would make it a priority to set aside the ‘found money’ for their retirement years.

More Boomers (27%) than Gen Xers (16%) and Millennials (6%) would first consider allocating a million-dollar lottery prize to their retirement funds.

Additionally, the most common factors competing with respondents’ regular retirement savings are unexpected costs (33%) and paying off big debts (31%). Paying off large debts (such as student loans) has competed with the retirement savings of more Millennials (38%) than any other generation.

On average, retired respondents stopped working at age 68; however, those who have not retired plan to at age 65. Single mass affluents, on average, plan to retire or have retired at age 62. More than two in five (41%) mass affluents who have not retired yet imagine that they’ll need an annual income somewhere in the $50,000 to $99,999 range when they retire.

About a quarter of Millennials (24%) and Gen Xers (25%) believe they’ll need at least $150,000 annually when they retire-far more than Boomers, with just 11% believing they’ll need that much income in retirement.

As for when people began saving for retirement:

Most (90%) of the mass affluent have retirement savings and began saving at 33 years old, but Millennials are planning for the future at a much younger age, with more than half (54%) starting between the ages of 18 to 24- Eighty percent of Millennials currently have retirement savings.

The most common trigger for those with retirement savings to begin investing for retirement was an account being offered at work (48%). Far fewer were spurred to invest due to major life events like getting married (18%) or having their first child (12%).

More millennials (36%) and Gen Xers (32%) than Boomers (15%) and Seniors (12%) were motivated to save for retirement when they started their first jobs. Almost three in ten (28%) Millennials first started saving for retirement after a raise or promotion at work, versus 10% of older generations.

The article can be read in the journal Pension Benefits. The report can also be viewed here.

 

Photo by 401kcalculator.org

Alicia Munnell: Should Insurers Handle Public Pension Payouts?

US Capitol dome

Last month, Pension360 covered the Urban Institute’s ringing endorsement of a Congressional bill that would let local governments turn over the assets of their pension plans to insurance companies, who would then make payments to retirees.

Senator Orrin Hatch proposed the bill, called the SAFE Retirement Plan.

On Wednesday, another major pension player threw their opinion in the ring: Alicia Munnell, director of the Center for Retirement Research at Boston College.

She begins by outlining why the Urban Institute likes the plan, and why the Pension Rights Center doesn’t:

The folks at the Urban Institute think that this plan is terrific. They gave it an “A” under all seven of their criteria: 1) rewarding younger workers; 2) promoting a dynamic workforce; encouraging work at older ages; 4) retirement income for short-term employees; 5) retirement income for long-term employees; 6) making required contributions; and 7) the funded ratio.

Essentially it does not allow sponsors to underfund plans (items 6 & 7) and provides a more equitable distribution of benefits across participants’ age demographics. That is, young and short-term workers get more benefits and older workers have less incentive to retire than under a traditional defined benefit plan. With their criteria, the Urban Institute researchers would always give a higher grade to any type of cash balance or defined contribution plan than to the current defined-benefit plan.

The Pension Rights Center lumps the Hatch proposal with other de-risking activities, such as General Motors transferring its retiree liability to Prudential. In the private sector, such a transfer means the loss of protection by the Pension Benefit Guaranty Corporation (PBGC), and reliance on the strength of the insurance company to provide the benefits. Such a loss does not occur in the case of state and local plans, because these plans are not covered by the Employee Retirement Income Security Act of 1974 and therefore benefits are not protected by the PBGC.

Munnell then delves into her own opinion:

First, I am not quite sure how it would work. In the private sector, a company can spin off only fully funded plans. But few public sector plans are fully funded. Is the suggestion to close down the current public sector defined benefit plan and send all future contributions to the insurance company? In many states that path would be quite difficult given that employers cannot reduce future benefits for current employees. So I am not clear how a SAFE Retirement Plan would actually be adopted.

Second, I am very concerned about costs. One issue is that investments would be limited to those acceptable for underwriting annuities, a requirement that means essentially an all-bond portfolio. Trying to produce an acceptable level of retirement income without any equity investments requires a very high level of contributions. My other concern on the cost side is fees; insurance companies need a significant payment to take on all the risks associated with providing annuities.

In short, the SAFE Retirement Plan doesn’t seem like either a feasible or efficient way to provide retirement income. Fortunately, the plan is optional. So, I’m moving on to other topics!

Munnell runs the Center for Retirement Research and the Public Plans Database.

The Dutch Pension System’s “Hidden Risk”

EU Netherlands

The Dutch pension system has been getting lots of press in recent days – a recent New York Times report and a PBS documentary from last year have espoused the virtues of the system, which covers 90 percent of workers while remaining well-funded.

But the system carries a “hidden risk” for participants. Allison Schrager explains in BusinessWeek:

Compared with defined-benefit plans in the U.S.—rare, underfunded, and governed by accounting standards derided by almost every economist—the Dutch pension system looks even better. It does have a weakness, though, one that’s often overlooked, even though it may be the only aspect of the Dutch system that’s likely to be adopted here: In the Netherlands, annual cost-of-living increases depend on the health of the pension’s balance sheet. If returns fall, benefits don’t increase. If the fund performs badly enough, pensioners may even suffer benefit cuts.

[…]

But to call it risk-sharing makes it sound more benign than it really is, particularly because retirees can’t tolerate as much risk as working people can. Post-retirement, most people live on a fixed income. In general, it’s too late to save more or get another job. Many state employees don’t have other sources of inflation-linked income like Social Security. If “fairness” means everyone has to bear risk equally, then the Dutch system makes sense. But if it’s more “fair” to treat people differently according to their means, then it would be better to share the risk with current workers instead.

Inflation risk may not seem like a big deal now. But the future is uncertain, which is why the guarantees are so valuable. Until the financial crisis, Dutch pensioners took it for granted they’d get their cost-of-living adjustment each year. Gambling on future inflation may be preferable to an underfunded pension—or no pension at all—but it’s no free lunch.

As Schrager points out, variations of the “risk-sharing” model have made their way to the United States:

This kind of risk-sharing has been catching on in America. Public pension benefits are often secured by state constitutions, but it’s not clear whether those guarantees extend to inflation-linked adjustments. Eager to contain costs, some states have eliminated cost-of-living increases entirely. The state of Wisconsin adopted a variant of the Dutch model in which retirees in the Wisconsin Retirement System get a cost-of-living adjustment only when pension assets return at least 5 percent. Previous inflation adjustments can be clawed back; monthly checks were 10 percent smaller in 2013 as a result of the financial crisis. Although, unlike in the Dutch plans, retirement income can never fall below its nominal level at retirement.

Stanford’s Josh Rauh and University of Rochester’s Robert Novy-Marx have projected that unfunded liabilities in the U.S. would fall by 25 percent if every state adopted Wisconsin’s pension model.