Tuesday, December 4, 2012

Cash Balance Plans

"The real reason that we can't have the Ten Commandments in a courthouse: You cannot post 'Thou shalt not steal,' 'Thou shalt not commit adultery,' and 'Thou shalt not lie' in a building full of lawyers, judges, and politicians. It creates a hostile work environment." – George Carlin

"A cash balance plan splits the difference in that it provides a guaranteed minimum benefit for every employee but has predictable and manageable cost and is not susceptible to abuse." - According to Rep. Dan Biss of Skokie, whose fingerprints are all over the proposed change.

Cash Balance Plan (…like a pension only really different)

Noun:  A Cash Balance Plan is just one of the many proposed moving parts put forth by Rep. Elaine Nekritz of Northbrook and Rep. Dan Biss of Skokie in another immoral attempt to stop Illinois' fiscal bleeding by bleeding the minority the General Assembly and the various Governors cheated to begin with.  Don't be fooled by the saccharine description that will by provided by legislators like Biss.  While they will promise you that a cash balance plan is a better compromise between the mismanagement of pensions and the risky self-management of 401(k)'s, it was never intended to provide for a stable retirement.   

A Cash Balance Plan is another variation on retirement savings plans developed in the 1980’s that is both deceptively simple yet devilishly complicated.  In its design, a Cash Balance Plan falls into the federally recognized arena of defined benefits (like a pension) as opposed to defined contributions (like a 401K).  There is no simple definition, so you’ll need to read on.

In essence, the employer credits a worker, like a teacher, each working year a percentage (usually 4 – 5%) of her salary, which becomes a “hypothetical” account balance that grows over the years.  For example, let’s say that Jane the reading teacher earns $30,000 in a year one of her work at the school.  Her “hypothetical” account would be 4% of $30,000.  That would equal $1,200.  Next year, Jane earns $32,000.  Add another 4% ($1,280), and Jane’s “hypothetical” account has now grown to $2,480.  Are you with me so far? 

Now let’s add another aspect to Jane’s  “hypothetical” account.  The employer will also provide an annual percentage rate as if the money accumulating in Jane’s hypothetical account were invested in something like an index or long-term Treasury bond.  Right now, T-Bonds are a little under 3%, but the employer will have to maintain that number and accept the risk throughout Jane’s tenure at the school.  In year one, Jane has no interest as her “hypothetical” account starts.  But in year two, she can figure an additional $34.80 in interest added to her “hypothetical” account.

By the way, hypothetical means just that.  There is no real money in any account, but the employer is responsible for actuarially maintaining that record for later dispersing of funds “hypothetically” earned.  

This alternative defined benefit plan has become the darling of Representative Biss’ approach to solving the “pension crisis.” In fact, Representative Biss (Skokie), whose proposal for a cash balance plan in HB1673 was deleted only after Speaker Madigan handed the dying bill to Rep. Cross last spring, still strongly considers this concept a positive alternative for both Tiers of public employees.  The plan in HB1673 was a replica of his initial proposal in his own HB6149.  Now we see its re-appearance in a proposed new bill HB6258 -  being launched in the Veto Session.  According to the legislator Biss, in the spring he wanted to make improvements to "the inadequate benefit offered Tier II employees and preserve the existing defined benefit… for Tier I employees" (Representative Biss in a May 2012 email communication).   Last spring Biss offered choices for cash balance plans.  His new proposal, on the oher hand, will place all new hires since 2011 in a Cash Balance Plan.   And, because of Representative Biss' connections to the pension committee, which will once again hammer out the details of the next proposals sure to come at us in November through January, we should all be aware of his involvement and strong advocacy for this kind of retirement plan.

Second, let me try and make this simple.  The main differences between reading teacher Jane’s defined benefit pension and a Cash Balance Plan(CBP) are these (to name a few):

A CBP is a slowly building “hypothetical account” which takes into account all of your years of service, and it is not calculated at all like our current pensions.  Many years from now, instead of calculating Jane’s retirement by averaging the last four years of her earnings and a percentage based upon the number of years of service, it will include all the early years for which Jane made very little compensation.  This is especially impactful for teachers who have received pay increases over the years as well as later increased compensation for educational advancements and degrees.

A CBP is a completely portable account; consequently, it is very alluring to those who move from one job to another (unlike most educators) and likewise serviceable to employers.  After two years of service, the State of Illinois  (or local school district – but that’s another earlier vocab) can cut a check for Jane for $2,480 and send her on her way.  Oops, she’ll also get that nearly 3% per year in hypothetical interest too.  Or $34.80.

Let’s talk about that interest, too.  What if returns on investments increase?  What if the Great Recession ends in the next ten or thirty years? What if the market returns on investments become much more than just under 3%.  Does Jane get that too?  Sorry, no.  The employer reaps any extras off of Jane’s hypothetical accounts.  Of course, the employer will argue that it took on the risk to begin with. 

Starting to see how this works?  Cash Balance Plans were first developed in the 1980’s by Kwasha-Lipton, a New Jersey investment firm,  as a means to capture surplus dollars from employee pension plans without running afoul of the IRS for not paying the federal taxes on money taken out of employee pension plans (Schulz, Ellen.  Retirement Heist). Regular pensions produce rapid growth in value at the end of a career, but by creating an instrument that grows slowly at a flat rate, money can be saved (or diverted) from pension responsibilities.  Multiple those by a hundred thousand or more, and you’ve made some seriously big money.  According to Schulz, Kwasha-Lipton partners determined savings of 25 – 40% in pension costs by converting to this “new, complicated” product.  To see just how smugly they celebrated their manipulation of middle class pension savings, take a look at some of their end-of-year parties.  One of the first companies to employ this new concept in order to re-direct funds destined for workers pensions was Bank of America.  I’m shocked?      

It gets worse.  When companies or the State of Illinois convert to a Cash Balance Plan, they freeze the old pension, ending its growth.  On occasion, the “old” pension is converted to a lump sum which becomes the new “hypothetical account balance.”  The balance now grows by a flat rate of 4%, killing any leveraged growth.  The older a worker, or the more time vested in the regular pension plan, the greater the suffering.  For example, a teacher like Kenneth, who has over 30 years in the system, my have an opening account balance of nearly $200,000 to start.  But remember that at 9.4% per year, Kenneth has already contributed well over that amount – more like $300,000.  It will take Ken many more years to build back that contribution amount.  When Cash Balance Plans emerged in the business world, age discrimination suits became a new growth industry.  Later legal federal adjustments were made to provide some protections for the elderly and vested employee.  On the other hand, these instruments and their half-sister, the 401 (k), were developed to provide portability to a more mobile work force and savings for employers who faced promises of pensions to an aging work force. 

Finally, Cash Balance Plans are required by law to fulfill at least one aspect of a defined benefit: they must provide an annuity payment for the balance of a retiree’s life (or offer a lump sum pay out).  Most workers wanting to manage their own end of life savings/retirement choose the latter, but others will accept the annual guaranteed pension benefit.  How much per month?  Unlike a pension, you’d better look at it from an annual perspective.  According to a recent CBS analysis of Cash Balance Plans vs. Insurance Annuities (2012), the average annual pay out for those who desire the CBP annuity for life is about $8,000 per year for every $100,000 saved in their eventual "hypothetical account." See cash balance retirement plans: annuity options.

At those rates, young Jane better have well over a million in her hypothetical account when its time to leave.  At those rates, the State of Illinois will be able to begin having public employees pay down the debt created by years of underfunding.  Indeed, the unfunded liability is expected to be completely taken care of in a mere thirty years if Rep. Nekritz and Rep. Biss can get HB6258 or another yet unnumbered bill passed.  

Stop the bleeding?  Remember, my fellow public employee, the target has always been you and me.

1 comment:

  1. The one thing that was incredibly clear to me was that advisors who sold annuities made a great deal of money. selling annuity payments