10 things credit union executives need to know about pensions and 401(k)s (webinar slides)

Our difference is your advantage

OUR DIFFERENCE IS YOUR ADVANTAGE

10 THINGS CREDIT UNION EXECUTIVES NEED TO KNOW ABOUT PENSIONS AND 401(K)S

Pete Swisher, CFP®, CPC Senior Vice President

National Sales Director

Pentegra Retirement Services

November 15, 2012


BACKGROUND

Focus of book: fiduciary

governance

National Association of Plan

Advisors (NAPA) Government

Affairs Chair


ABOUT PENTEGRA

Founded in 1943 as a not-for-profit cooperative

serving the Federal Home Loan Bank system

One of the nation’s top pension managers (top 10% in

S&P Money Management Directory)

Nearly 70 years’ experience with full fiduciary

outsourcing through its unique Multiple Employer

Plans for financial institutions

Retirement plan service provider for nearly 10% of all

banks and credit unions in the U.S.


10 THINGS

No. 1: Interest rates

No. 2: Tax reform done badly

No. 3: Fiduciary outsourcing

No. 4: The primary risk

No. 5: Most plans can cut costs 20% or more

No. 6: The irreproachable way to run a plan

No. 7: Fiduciaries can and should protect themselves

No. 8: Fee disclosure is not fee clarity

No. 9: How pension “cost” hits your financials is tricky

No. 10: Cheapest way to terminate a pension plan

No. 11 (bonus): Don’t terminate, redesign



Defined benefit (DB) pension plans will

get cheaper as rates go up.

Defined contribution (DC) participants

will likely handle rising rates the same

way they have historically—badly.

Interest rates can’t get much

lower…honest

No. 1

Source: What Drives The Bond Market?

Chicago CFA Handout by Bianco Research LLC, 1/18/2011

http://www.ritholtz.com/blog/wp-content/uploads/2012/01/Long-Term.png

http://www.arborresearch.com/bianco/?page_id=46908


IMPLICATIONS OF RATE ENVIRONMENT

The perfect storm for DB plan funding cost is over

As rates rise DB plans get cheaper

2% rate increase takes a plan that is 80% funded to

100% funded

Lower rates are possible but there’s not much

room between here and zero—new cost burdens

are therefore increasingly unlikely

Now is the time to plan for the future of your

pension program



If contributions are no longer deductible

people will contribute less.

Less savings means greater strain on

public systems such as Social Security,

Medicaid, and Food Stamps.

Tax reform done badly is bad for

everyone…and is being considered

No. 2


BAD TAX REFORM

Sampling of proposals:

Bowles-Simpson “Zero” option and 20/20 option

Transfer payments via refundable tax credits

Result: retirement saving decreases significantly, including

among the lowest income earners

8-24% reduction in long term savings per EBRI Issue Brief No. 364

Less savings means more pressure on government spending

in the future for Social Security, Medicaid, Food Stamps,

and other social insurance programs

Why it’s being considered: higher taxes packaged as flatter

brackets as part of a plan to reduce deficits


“HOW AMERICA SAVES” (visit asppa.org)

62% of tax incentives are received by households with AGI

less than $100,000

EBRI estimates a 14% reduction in retirement savings under

the 20/20 proposal for younger workers in the lowest

earnings quartile; the loss is 24% under the “zero option”

72% of low and moderate income workers participate in a

plan when offered at work but only 5% save in an IRA when

there is no workplace plan

78% of full-time workers have access to a plan at work



Most credit unions serve as Named

Fiduciary, Plan Administrator, and Trustee

(or “direct” the Trustee), but could

outsource instead.

Outsourcing means less work and less risk.

Fiduciary outsourcing can save time,

money, risk, and headaches

No. 3


WORKLOAD FOR COMPANIES WHO HOLD ONTO THE FIDUCIARY ROLE

4-5 two-hour meetings per year for 3-5 people, usually

senior people, with preparation and follow-up between

A host of minor tasks such as approving and documenting

hardships, QDROs, and other distributions

Auditor selection and oversight and coordination of the

audit; preparation of plan financials

Checklists and processes (or ignoring the details)

Focusing on details instead of the big picture


CASE STUDY

CFO fills Administrator role and is very experienced

CFO retires and successor knows less about plans

Auditor discovers two defects

Burdens as described by new CFO: learning curve, anxiety,

direct costs of correction (IRS user fee, legal fees, penalties

and interest), “huge time cost”, anger



Very few ERISA lawsuits are about

retirement plan investments.

The overwhelming source of trouble for

retirement plan sponsors is administration.

The primary source of fiduciary risk is

administration, not investments

No. 4


STATISTICS AND SURPRISES

10,002 Forms 5500 audited

5,973 VCP agreements

3,472 DOL civil investigations closed

75% resulted in payment

Average $397,000

255 cases referred for litigation by DOL, 75 convictions

8,860 ERISA lawsuits

Sources: 2011 data from IRS and DOL websites


The IRS Top Ten List of Common VCP Submissions

1. Failure to amend for tax law changes

2. Incorrect definition of compensation

3. Failure to include eligible employees or exclude ineligibles

4. Loan errors

5. Impermissible in-service withdrawals

6. Required Minimum Distribution errors

7. Employer eligibility failure

8. ADP/ACP failure not timely corrected

9. Failure to provide minimum top heavy benefit

10. Exceeding maximum contribution limits

From the IRS Website at http://www.irs.gov/retirement/article/0,,id=155383,00.html

Copyright 2012 Pentegra

Retirement Services © All

Rights Reserved

http://www.irs.gov/retirement/article/0,,id=155383,00.html

http://www.irs.gov/retirement/article/0,,id=155383,00.html


TWO WAYS TO GET OUTSOURCING

Pentegra’s Multiple Employer Plans (MEPs)

Pentegra’s Full Fiduciary Outsourcing program



Most plans can cut costs but probably shouldn’t do

so: the point is to recognize that it’s possible and to

have a fiduciary rationale for your approach.

Indexing, advisory “right-sizing,” and affordable

recordkeeping options are the cost drivers.

Most plans can cut costs by at least 20%

No. 5


SMALL 401(K) CASE STUDY

Cost Item Current Net Cost Possible Cost

Funds .50% .09%

Recordkeeping .75% .60%

Advisor .40% .30%

Total 1.65% .99%

Remember that the point of these illustrations is not that cheaper is better but

that the existence of cheaper alternatives requires you to have a rationale.


LARGE 401(K) CASE STUDY


Funds .35% .09%

Recordkeeping .35% .22%

Advisor .20% .07%

Total .90% .38%


DEFINED BENEFIT CASE STUDY


Investment Fees .35% .09%

Admin/Actuary .35% .26%

Advisor .40% .25%

Total 1.10% .60%


WHY 20% SAVINGS IS NOT A STRETCH

Fund expense is the primary cost driver and indexing is

always a valid option

“Right-sizing” the services of an advisor can raise or lower

cost; the emphasis here is less on cost and more on what

you get for what you pay

Productivity gains in recordkeeping and administration are

not always passed on to clients: again, the question is what

you get for what you pay


WHY CHEAPER MAY NOT BE BETTER

Cheaper is neither better nor legally required

What is required is that you choose your mix of services

wisely and pay fair prices for those services

Full fiduciary outsourcing is more expensive than basic

recordkeeping; active management costs more than

indexing; handholding and employee advice cost more

than occasional group education; excellence costs more

than mediocrity. You get what you pay for. Just make sure

you know what you’re getting.



Focus on best fiduciary practices, best

outcomes for participants, and paying

precisely the correct price to achieve them.

“Irreproachable” is not the same as “best.”

There is an irreproachable way to run a

retirement plan

No. 6


PROFILE OF A PLAN NO ONE CAN CRITICIZE

“Cheapest to Deliver” or CTD investing

“10 of 10” fiduciary governance

Great participant outcomes

Note the emphasis here on what can be criticized: what may

be best for you and your employees goes beyond what

others think. Service, for example, obviously matters.



Understand what you’re getting yourself

into when you accept fiduciary status.

Follow the four part program.

Fiduciaries can and should take steps to

mitigate their personal liability exposure

No. 7


What happened to Ayres

“…[w]hile we are not unsympathetic to his burden, we note that

fiduciaries may be insured for this type of liability. It would appear

that prudent fiduciaries would have their plan or employers secure

such insurance. In any event, when we consider the overall

purposes of ERISA as a remedial statute designed to protect the

interests of employees in pension plans…we believe the

participants’ rights are the ones entitled to protection.”

From the court opinion in Barker v. American Mobil Power Corp., in

which the court imposed a large financial penalty on a defendant

named Ayres for a breach by Ayre’s predecessor that Ayres failed

to notice and correct.


Four-Part Program for Mitigating Fiduciary Risk

Outsource the Named Fiduciary, ERISA Sec.

3(16)(A) Plan Administrator, and Trustee roles to

a regulated financial institution who specializes

in fiduciary management of qualified plans.

Hire an independent advisor to help oversee the

plan fiduciary

Buy fiduciary liability insurance

Insist on an indemnification agreement


CASE STUDY: PENTEGRA’S MEPS

Non-recourse fiduciary liability insurance

Full fiduciary outsourcing

CEM Benchmarking retained by the plan’s Board of

Directors to study Pentegra’s costs and services versus the

marketplace

An independent fiduciary approves Pentegra’s fees



There are three separate disclosures and

they never match.

Sponsors still have a hard time answering

a simple question: “What am I paying,

and what am I getting for it?”

Fee disclosure is not fee clarity

No. 8


THREE LOCATIONS FOR FEE DATA

408b-2 disclosure to plan sponsor and fiduciaries

404a-5 participant disclosure

Form 5500 Schedules A and C

If you study all three you will find no consistency because of

how the regulations are written



Pension costs are a future unknown that

actuaries can only estimate.

The rules for booking the costs are

complex and often seem to bear little

relation to the actual flow of dollars.

What a pension plan “costs” is not the

same as how it affects your financials

No. 9


HOW PENSION COSTS HIT THE FINANCIALS

You don’t necessarily recognize pension contributions as

an expense when you make them.

Unrecognized contributions pile up (“prepaid” expenses).

If you terminate with a large prepaid you take a big hit to

earnings.

Remember that the cost is what it is, but how the cost is

accounted for is something else entirely. Managing the

financials is generally as important to credit unions (or more

so) than managing the cost.


CURRENT FUNDING STATS

ERISA Funding

Assets $6.7 million

Liabilities $7.6 million

Actuarial Shortfall $900,000

Termination Liability $9.9 million

Termination Shortfall $3.2 million

Accounting Treatment

Prepaid Expense $4 million

Ideal Annual Expense $350,000

Current Expense $450,000+


CURRENT ANNUAL EXPENSE

Interest on $6.7 million assets at 2.75%

= $185,000

Interest on $7.6 million liabilities

= $368,000

$5 million AOCI amortized over 15 years

= $284,000

Total: $467,000 per year


ANNUAL EXPENSE AT 110% FUNDING

Interest on $8.3 million assets at 6%

= $500,000


= $368,000


= $284,000

Total: $152,000 per year based on $1.7 million contribution


ANNUAL EXPENSE AT 154% FUNDING

Interest on $12.7 million assets at 6%

= $762,000


= $368,000


= $284,000

Total: -$110,000 per year ($110,000 of income) based on $6

million contribution



There is such a method but it is impossible

to predict. But it is possible to develop

and implement a plan for getting as

close as possible. Be proactive.

There is a cheapest, lowest risk method

for terminating a pension plan

No. 10


LEAST COST PENSION TERMINATIONS

Proactive Plan: 0, 3, 5, 10, 15 year windows

Opportunistic approach based on an annual review of

capital market forecasts, interest rates, and annuity costs

Rule of thumb approach to estimating termination liability

(“street liability”)

Annuities are more expensive than lump sums and long

term management may be cheapest of all

The plan must manage the impact on credit union

financials



For participants there is no comparison:

DB plans are better in nearly every way.

But the cost and cost volatility are what

kill these programs. Solution: redesign,

don’t terminate.

DON’T TERMINATE: REDESIGN

No. 11 (Bonus)


DEFINED BENEFIT VS. DEFINED CONTRIBUTION

46% lower cost to deliver a given benefit

Sources of savings (from “Better Bang for the Buck,” a

National Institute of Retirement Security study, 2008):

15% Longevity risk pooling

5% diversification and investment balance

26% superior investment returns

Numerous studies over the years have confirmed the DB

performance advantage. Globally the source is believed to be

the “self-direction penalty.”

Global Perspective


CLOSING RECOMMENDATIONS

Outsource

Know what you’re paying and what for. Avoid paying

premium prices without demonstrable benefits.

Be proactive. Examine your program design and look for

ways to make it better.

If you have a DB pension plan, proactive planning is

especially important. Redesign if costs are too high.

Rely on Pentegra.



THANK YOU!

Pete Swisher, CFP®, CPC Senior Vice President

National Sales Director

Pentegra Retirement Services

[email protected]

10 things credit union executives need to know about pensions and 401(k)s (webinar slides)

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