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Pension reform bill - similar effects to the failed SS reforms
- Thread starter drsteph
- Start date
Apologies for the delayed post. I was just finishing up a prior post on gold when this idea popped into my head. Of course, I was running out the door to a meeting, so this had to wait until I got back. I have not been able to do a full due diligence on this yet, so please consider it a work-in-progress.
For those of you who have read some of my previous posts, Iâm a big fan of âits about the demographics, Stupid.â http://www.elitetrader.com/vb/showthread.php?s=&postid=640791&highlight=demographics#post640791 While I am not a Harry Dent disciple, I do agree that mass migrations in both people and capital occur on a relatively predictable manner due to peopleâs age and location. You can tie that in to generational stages, and even kondrietaff cycles, if you wish. But without getting into the mumbo-jumbo, thereâs certainly enough meat to the argument to support it â in fact, you could point to much of the last 30 yearâs stock market run-up and growth in the mutual fund industry and explain it away with demographics.
So, it follows that when those who have invested in mutual funds must convert them to cash to fund their retirement, it has been proposed that there will be a crash in equity markets and bond yields will drop to almost nothing, particularly on the long end of the curve. The only way out of this is to engineer a transfer of wealth between the generations. But with 40+ million baby boomer households and only 18million gen Xâer households, the math doesnât work.
In my opinion, this was the purpose behind Bushâs social security reform package. http://www.elitetrader.com/vb/showthread.php?s=&postid=659990#post659990
But that was defeated. So, enter the Pension Protection Act of 2006. In addition to the expected stuff, like the repeal of the EGTRRA sunset provisions in 2010, there were some interesting additions. Like transferability of the ERISA accounts to non-spousal designated beneficiaries, automatic enrollment in 401k plans, and allowing pension plans to give investment advice. Furthermore, there are âdefault investmentâ plans required for these automatic plans which are probably going to be either a 60/40 balanced fund or some sort of âlifestyleâ age-related fund (with higher %tages of equities at younger ages). http://www.shrm.org/issues/pension/
Continued....
For those of you who have read some of my previous posts, Iâm a big fan of âits about the demographics, Stupid.â http://www.elitetrader.com/vb/showthread.php?s=&postid=640791&highlight=demographics#post640791 While I am not a Harry Dent disciple, I do agree that mass migrations in both people and capital occur on a relatively predictable manner due to peopleâs age and location. You can tie that in to generational stages, and even kondrietaff cycles, if you wish. But without getting into the mumbo-jumbo, thereâs certainly enough meat to the argument to support it â in fact, you could point to much of the last 30 yearâs stock market run-up and growth in the mutual fund industry and explain it away with demographics.
So, it follows that when those who have invested in mutual funds must convert them to cash to fund their retirement, it has been proposed that there will be a crash in equity markets and bond yields will drop to almost nothing, particularly on the long end of the curve. The only way out of this is to engineer a transfer of wealth between the generations. But with 40+ million baby boomer households and only 18million gen Xâer households, the math doesnât work.
In my opinion, this was the purpose behind Bushâs social security reform package. http://www.elitetrader.com/vb/showthread.php?s=&postid=659990#post659990
But that was defeated. So, enter the Pension Protection Act of 2006. In addition to the expected stuff, like the repeal of the EGTRRA sunset provisions in 2010, there were some interesting additions. Like transferability of the ERISA accounts to non-spousal designated beneficiaries, automatic enrollment in 401k plans, and allowing pension plans to give investment advice. Furthermore, there are âdefault investmentâ plans required for these automatic plans which are probably going to be either a 60/40 balanced fund or some sort of âlifestyleâ age-related fund (with higher %tages of equities at younger ages). http://www.shrm.org/issues/pension/
Continued....
2nd part of a 2 part post
Requirements for traditional (Defined Benefit) plans have become much more stringent, and if Iâm not mistaken, there was a recent court case that allowed a company to switch from a DB plan to a DC 401k type plan without its members approval (Illinois or Michigan supreme court, recent news but canât find a good link to the case. any legal types know the details?). DB plans LOVE bonds because of legal compliance issues. With current low yields, the DB plans are de facto underfunded (in addition to corporate neglect causing underfunding). But, since long term rates seem determined to remain below 6% for perhaps the rest of our lives, the DB plans will never be fully funded, and will be transferred ultimately to the PBGC, and thatâs the big 800 lb gorilla looming on the horizon. As the number of DB plans falls, it relieves pressure on the long end of the curve, and may allow those rates to rise (barring deflationary issues) to more reasonable rates which might keep these old-style plans solvent longer.
SO, if you read between the lines in the context I have given you, you can see how this approach could serve much the same function as the failed social security proposals and support the equity markets by either mandating, recommending, or favoring equity purchases through these default funds (while preventing a bond yield disaster). The question then is â HOW MUCH. Will the capital inflows be small, moderate, or major? Is it sufficient to prevent a long term crash or will it do the opposite and create a new equity boom?
This is a really rough argument, and I am sure there are plenty of holes here. But, I think there is something really here. Depending on the numbers, it could be big or it could be negligible. Are there any economists here that would like to take a shot at this, since I have no idea where and how to begin, and if it is going to be big, I assure you that it is bigger than all of us together and there is not going to be any âedgeâ or secret about this very long term change in regulations to support favored investments.
Someone smarter than me take this and run with it, but please come back to let us know what you think!
Requirements for traditional (Defined Benefit) plans have become much more stringent, and if Iâm not mistaken, there was a recent court case that allowed a company to switch from a DB plan to a DC 401k type plan without its members approval (Illinois or Michigan supreme court, recent news but canât find a good link to the case. any legal types know the details?). DB plans LOVE bonds because of legal compliance issues. With current low yields, the DB plans are de facto underfunded (in addition to corporate neglect causing underfunding). But, since long term rates seem determined to remain below 6% for perhaps the rest of our lives, the DB plans will never be fully funded, and will be transferred ultimately to the PBGC, and thatâs the big 800 lb gorilla looming on the horizon. As the number of DB plans falls, it relieves pressure on the long end of the curve, and may allow those rates to rise (barring deflationary issues) to more reasonable rates which might keep these old-style plans solvent longer.
SO, if you read between the lines in the context I have given you, you can see how this approach could serve much the same function as the failed social security proposals and support the equity markets by either mandating, recommending, or favoring equity purchases through these default funds (while preventing a bond yield disaster). The question then is â HOW MUCH. Will the capital inflows be small, moderate, or major? Is it sufficient to prevent a long term crash or will it do the opposite and create a new equity boom?
This is a really rough argument, and I am sure there are plenty of holes here. But, I think there is something really here. Depending on the numbers, it could be big or it could be negligible. Are there any economists here that would like to take a shot at this, since I have no idea where and how to begin, and if it is going to be big, I assure you that it is bigger than all of us together and there is not going to be any âedgeâ or secret about this very long term change in regulations to support favored investments.
Someone smarter than me take this and run with it, but please come back to let us know what you think!
Interesting Post, Drsteph. Before DG versus DC plans can be discussed intelligently, however, some common "knowledge" regarding these alternative plans that is dead wrong needs to be exposed.
The first is the nutty idea that one plan or the other is superior, when to compare them is actually to compare apples and oranges. DB plans (assuming of course that they are properly managed) provide a set income for life without significant risk of running out of money and with far less total contribution into the plan, but do not provide any estate to be left to heirs upon the beneficiary's death.
DC plans, by contrast, require a much higher level of contribution to assure that a set income will be provided for life, but do offer some chance of leaving an estate to heirs upon death of the beneficiary, especially if the benficiary dies relatively early.
Most people, if they really understood the fundamental difference between these two entirely different approaches to providing income in old age, would certainly choose the safety and much lower cost of the DB plan, with the option to make contributions to an additional DC plan. This is the system we have now, and where it has not been abused, is working very well.
One should not use the failure of horribly managed, even fraudulent in some cases, corporate DB plans, as an indication of anything other than the well-known fact that when you let the fox into the hen house there is bound to be trouble.
It is also interesting to note that despite the loud political fracas Re Social Security, the adjustments needed to assure soundness far into the future, are, if not delayed, trivial. One can only conclude that this ruckus was raised for diabolical reasons, but what were they? I'll be damned if I know, though in cynical moments i have my suspicions..
The first is the nutty idea that one plan or the other is superior, when to compare them is actually to compare apples and oranges. DB plans (assuming of course that they are properly managed) provide a set income for life without significant risk of running out of money and with far less total contribution into the plan, but do not provide any estate to be left to heirs upon the beneficiary's death.
DC plans, by contrast, require a much higher level of contribution to assure that a set income will be provided for life, but do offer some chance of leaving an estate to heirs upon death of the beneficiary, especially if the benficiary dies relatively early.
Most people, if they really understood the fundamental difference between these two entirely different approaches to providing income in old age, would certainly choose the safety and much lower cost of the DB plan, with the option to make contributions to an additional DC plan. This is the system we have now, and where it has not been abused, is working very well.
One should not use the failure of horribly managed, even fraudulent in some cases, corporate DB plans, as an indication of anything other than the well-known fact that when you let the fox into the hen house there is bound to be trouble.
It is also interesting to note that despite the loud political fracas Re Social Security, the adjustments needed to assure soundness far into the future, are, if not delayed, trivial. One can only conclude that this ruckus was raised for diabolical reasons, but what were they? I'll be damned if I know, though in cynical moments i have my suspicions..
Oh, this is getting more interesting all the time.
While I am having trouble finding the link, I distinctly recall recently a piece written on the default investment category being US Equities.
Long-term capital appreciation = synonym for large cap blend or growth equities.
Capital Preservation = synonymous for cash or long term bonds
Blend = synonymous with a âbalancedâ 60/40 fund.
Any portfolio managers or government types care to pipe up as to what they think on a legal basis constitutes these asset classes?
And hereâs a neat question â
What would happen to the US equity markets if a dollar devaluation and rising long term rates occurred simultaneously? How would foreign investors react if their foreign Eurodollar holdings were to be devalued? Would they buy US equities and prop up the equity market, particularly if from their perspective, US equities were cheap?
Keep readingâ¦
III. Default investments
Current Law: ERISA section 404(c) provides relief to fiduciaries to the extent participants direct the investment of their own accounts under the plan. Section 404(c) does not provide fiduciaries relief where a participant does provide investment direction and their accounts are invested in the planâs âdefaultâ investment.
PPA: As directed by PPA, the Department of Labor issued regulations providing safe harbor guidance on the designation of default investments under ERISA section 404(c). The default investments should include âa mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend or both.â
IV. Investment advice
Current Law: ERISA restricts fiduciaries from entering into specific âprohibited transactionsâ as provided under ERISA. Under current law, it is difficult for a party to provide investment advice to a plan participant without violating one or more of ERISAâs prohibited transactions if the adviser receives compensation from the investment provider.
PPA: The new law provides an exemption to ERISAâs prohibited transaction rules for advice provided by a âfiduciary adviserâ under an âeligible investment advice arrangement.â The exemption covers advice provided to a participant in the plan, but not advice to the plan. In order to qualify for the exemption, the eligible arrangement must either (1) provide that the fees or other compensation received by the fiduciary adviser do not vary depending on the investment option chosen or (2) use a computer model under an investment advice program meeting certain criteria. An independent fiduciary would need to approve the arrangement.
The fiduciary adviser also would be required to provide advice in a format designed to be reasonably understood by the average investor. Plan participants must receive notices regarding the fiduciary advisorâs relationship to the investment provider among other requirements.
http://www.biztimes.com/news/2006/10/27/pension-protection-act-changes-401k-provisions
While I am having trouble finding the link, I distinctly recall recently a piece written on the default investment category being US Equities.
Long-term capital appreciation = synonym for large cap blend or growth equities.
Capital Preservation = synonymous for cash or long term bonds
Blend = synonymous with a âbalancedâ 60/40 fund.
Any portfolio managers or government types care to pipe up as to what they think on a legal basis constitutes these asset classes?
And hereâs a neat question â
What would happen to the US equity markets if a dollar devaluation and rising long term rates occurred simultaneously? How would foreign investors react if their foreign Eurodollar holdings were to be devalued? Would they buy US equities and prop up the equity market, particularly if from their perspective, US equities were cheap?
Keep readingâ¦
Knew it was there...
If you look at target retirement funds, their asset allocation is as follows (using Vanguard as an example):
1. for a 28 year old worker retiring in 2045 - 89.9% equities
2. for a 38 year old worker retiring in 2035 - 89.9% equities
3. for a 48 year old worker retiring in 2025 - 79.8% equities
4. for a 58 year old worker retiring in 2015 - 64% equities
5. for a 63 year old worker retiring in 2010 - 55% equities
6. for a retired worker (target retirement 2005) - 45% equities[/b]
in other words, "thou shalt buy and hold equities".
If you disagree with my premise, please read the following:
http://www.usanext.org/full_story.cfm?article_id=13&category_id=3
anyone else picking up on this? I feel like I'm writing for an audience of one occasionally.
Investment of Assets Absent Participant Election. The Act provides that, for purposes of ERISA Section 404(c),4 a participant is treated as exercising control with respect to assets in the participantâs account if such assets are invested in a âdefault investmentâ in accordance with forthcoming Department of Labor (âDOLâ) regulations until such time as the participant actually exercises control by making an affirmative investment election. Default investments are often utilized in situations where a participant in a plan providing participant-directed investments fails to provide any such direction for plan contributions made on the participantâs behalf. The prevalence of default investments is certain to increase given the Actâs future safe harbor treatment of plans with qualified automatic enrollment features.
The Act specifies that the DOL regulations be issued within six months following the Actâs enactment and that they provide guidance on designating certain investments as default investments, as well as the appropriate mix of asset classes considered to be consistent with long-term capital appreciation or long-term capital preservation (or a blend of both). This should provide support for existing default investment practices that make use of lifecycle and target retirement date funds rather than money market and stable value funds.
Before a participantâs account is first invested in a default investment, notice must be provided so that the participant has a reasonable period of time to actually make an affirmative investment election before the default investment is made. The notice must contain an explanation of the participantâs right to specifically direct investment of the assets in the account and the manner in which contributions will be invested absent any participant investment direction.
This provision is effective for plan years beginning after December 31, 2006.
http://www.cooley.com/news/alerts.aspx?ID=000039961820
If you look at target retirement funds, their asset allocation is as follows (using Vanguard as an example):
1. for a 28 year old worker retiring in 2045 - 89.9% equities
2. for a 38 year old worker retiring in 2035 - 89.9% equities
3. for a 48 year old worker retiring in 2025 - 79.8% equities
4. for a 58 year old worker retiring in 2015 - 64% equities
5. for a 63 year old worker retiring in 2010 - 55% equities
6. for a retired worker (target retirement 2005) - 45% equities[/b]
in other words, "thou shalt buy and hold equities".
If you disagree with my premise, please read the following:
http://www.usanext.org/full_story.cfm?article_id=13&category_id=3
anyone else picking up on this? I feel like I'm writing for an audience of one occasionally.
Boys and girls, the rules of the game are changing. Now you don't have access to hedge funds like you used to, since if you don't have 2.5 million, you're not 'really' rich.
Can I offer you some nice mutual funds instead?
http://www.elitetrader.com/vb/showthread.php?s=&threadid=82709&perpage=6&pagenumber=1
Can I offer you some nice mutual funds instead?
http://www.elitetrader.com/vb/showthread.php?s=&threadid=82709&perpage=6&pagenumber=1