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10 Things Credit Union Executives Need to Know about Pensions and 401(k)s (Webinar Slides)

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National retirement policy is becoming a topic of conversation not just in Washington but in boardrooms all over the U.S. and is shaping how credit unions structure and govern their retirement …

National retirement policy is becoming a topic of conversation not just in Washington but in boardrooms all over the U.S. and is shaping how credit unions structure and govern their retirement programs. Learn more at: www.nafcu.org/pentegra

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  • 1. 10 THINGS CREDIT UNION EXECUTIVES NEEDTO KNOW ABOUT PENSIONS AND 401(K)SOur difference is your advantagePete Swisher, CFP®, CPCSenior Vice PresidentNational Sales DirectorPentegra Retirement ServicesNovember 15, 2012 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 2. BACKGROUND Focus of book: fiduciary governance National Association of Plan Advisors (NAPA) Government Affairs Chair OUR DIFFERENCE IS YOUR ADVANTAGE
  • 3. 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 4. 10 THINGSNo. 1: Interest ratesNo. 2: Tax reform done badlyNo. 3: Fiduciary outsourcingNo. 4: The primary riskNo. 5: Most plans can cut costs 20% or moreNo. 6: The irreproachable way to run a planNo. 7: Fiduciaries can and should protect themselvesNo. 8: Fee disclosure is not fee clarityNo. 9: How pension “cost” hits your financials is trickyNo. 10: Cheapest way to terminate a pension planNo. 11 (bonus): Don’t terminate, redesign OUR DIFFERENCE IS YOUR ADVANTAGE
  • 5. No. 1 Interest rates can’t get muchOur difference is your advantage lower…honest 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 6. Source: What Drives The Bond Market?Chicago CFA Handout by Bianco Research LLC, 1/18/2011
  • 7. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 8. No. 2 Tax reform done badly is bad forOur difference is your advantage everyone…and is being considered 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 9. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 10. “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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 11. No. 3 Fiduciary outsourcing can save time,Our difference is your advantage money, risk, and headaches 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 12. WORKLOAD FOR COMPANIES WHOHOLD 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 13. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 14. No. 4 The primary source of fiduciary risk isOur difference is your advantage administration, not investments Very few ERISA lawsuits are about retirement plan investments. The overwhelming source of trouble for retirement plan sponsors is administration. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 15. 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 lawsuitsSources: 2011 data from IRS and DOL websites OUR DIFFERENCE IS YOUR ADVANTAGE
  • 16. The IRS Top Ten List of Common VCP Submissions1. Failure to amend for tax law changes2. Incorrect definition of compensation3. Failure to include eligible employees or exclude ineligibles4. Loan errors5. Impermissible in-service withdrawals6. Required Minimum Distribution errors7. Employer eligibility failure8. ADP/ACP failure not timely corrected9. Failure to provide minimum top heavy benefit10. Exceeding maximum contribution limitsFrom the IRS Website at http://www.irs.gov/retirement/article/0,,id=155383,00.html OUR DIFFERENCE IS YOUR ADVANTAGE Copyright 2012 Pentegra
  • 17. TWO WAYS TO GET OUTSOURCING Pentegra’s Multiple Employer Plans (MEPs) Pentegra’s Full Fiduciary Outsourcing program OUR DIFFERENCE IS YOUR ADVANTAGE
  • 18. No. 5Our difference is can cut costsMost plans your advantage by at least 20% 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 19. 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 20. LARGE 401(K) CASE STUDY Cost Item Current Net Cost Possible Cost Funds .35% .09% Recordkeeping .35% .22% Advisor .20% .07% Total .90% .38% OUR DIFFERENCE IS YOUR ADVANTAGE
  • 21. DEFINED BENEFIT CASE STUDY Cost Item Current Net Cost Possible Cost Investment Fees .35% .09% Admin/Actuary .35% .26% Advisor .40% .25% Total 1.10% .60% OUR DIFFERENCE IS YOUR ADVANTAGE
  • 22. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 23. 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 24. No. 6 There is an irreproachable way to run aOur difference is your advantage retirement plan 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.” OUR DIFFERENCE IS YOUR ADVANTAGE
  • 25. PROFILE OF A PLAN NO ONE CANCRITICIZE “Cheapest to Deliver” or CTD investing “10 of 10” fiduciary governance Great participant outcomesNote the emphasis here on what can be criticized: what maybe best for you and your employees goes beyond whatothers think. Service, for example, obviously matters. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 26. No. 7 Fiduciaries can and should take steps toOur difference is your advantage mitigate their personal liability exposure Understand what you’re getting yourself into when you accept fiduciary status. Follow the four part program. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 27. What happened to Ayres“…[w]hile we are not unsympathetic to his burden, we note thatfiduciaries may be insured for this type of liability. It would appearthat prudent fiduciaries would have their plan or employers securesuch insurance. In any event, when we consider the overallpurposes of ERISA as a remedial statute designed to protect theinterests of employees in pension plans…we believe theparticipants’ rights are the ones entitled to protection.”From the court opinion in Barker v. American Mobil Power Corp., inwhich the court imposed a large financial penalty on a defendantnamed Ayres for a breach by Ayre’s predecessor that Ayres failedto notice and correct. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 28. Four-Part Program forMitigating 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 29. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 30. No. 8Our difference is your is not feeFee disclosure advantage clarity 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?” OUR DIFFERENCE IS YOUR ADVANTAGE
  • 31. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 32. No. 9 What a pension plan “costs” is not theOur difference is your advantage same as how it affects your financials 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 33. 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 34. CURRENT FUNDING STATSERISA Funding Assets $6.7 million Liabilities $7.6 million Actuarial Shortfall $900,000 Termination Liability $9.9 million Termination Shortfall $3.2 millionAccounting Treatment Prepaid Expense $4 million Ideal Annual Expense $350,000 Current Expense $450,000+ OUR DIFFERENCE IS YOUR ADVANTAGE
  • 35. CURRENT ANNUAL EXPENSEInterest on $6.7 million assets at 2.75% = $185,000Interest on $7.6 million liabilities = $368,000$5 million AOCI amortized over 15 years = $284,000Total: $467,000 per year OUR DIFFERENCE IS YOUR ADVANTAGE
  • 36. ANNUAL EXPENSE AT 110% FUNDINGInterest on $8.3 million assets at 6% = $500,000Interest on $7.6 million liabilities = $368,000$5 million AOCI amortized over 15 years = $284,000Total: $152,000 per year based on $1.7 million contribution OUR DIFFERENCE IS YOUR ADVANTAGE
  • 37. ANNUAL EXPENSE AT 154% FUNDINGInterest on $12.7 million assets at 6% = $762,000Interest on $7.6 million liabilities = $368,000$5 million AOCI amortized over 15 years = $284,000Total: -$110,000 per year ($110,000 of income) based on $6million contribution OUR DIFFERENCE IS YOUR ADVANTAGE
  • 38. No. 10 There is a cheapest, lowest risk methodOur difference is your advantage for terminating a pension plan 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 39. 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 OUR DIFFERENCE IS YOUR ADVANTAGE
  • 40. No. 11 (Bonus)DON’T TERMINATE: REDESIGNOur difference is your advantage 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 41. 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.” OUR DIFFERENCE IS YOUR ADVANTAGE
  • 42. Global Perspective
  • 43. 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. OUR DIFFERENCE IS YOUR ADVANTAGE
  • 44. THANK YOU!Our difference is your advantagePete Swisher, CFP®, CPCSenior Vice PresidentNational Sales DirectorPentegra Retirement Servicespswisher@pentegra.com OUR DIFFERENCE IS YOUR ADVANTAGE