What is hyper inflation? How can you protect your investments from inflation?

Hyperinflation is the term given to describe inflation that is spiraling out of control. Where prices are rising very quickly whilst the value of the currency of the country is falling. During less turbulent times reports on inflation are made yearly but when hyperinflation takes over it is reported on a period as little as one month.

There is much discussion on the causes of hyperinflation but it becomes most noticeable when there is a large and sudden increase in the quantity of money available but where there is no corresponding increase in growth either by output of product or services. This creates a lack of balance and confidence is lost in the currency. Governments often print large amounts of money in an attempt to stimulate the economy, however this can have an adverse effect when devaluation of the currency is happening faster that the rate at which the money is being printed. Hyperinflation has in the past commonly been related to paper money, as it is easier to print money by either reprinting old notes or by altering the printing plates.

Hyperinflation totally devalues savings both public and private. The economy of the country is distorted and nobody wants to invest there. Extreme remedial measures have to be taken by the governing body to try and solve the problems. These remedial measures vary from drastically cutting government expenditure to changing the basis of the currency. Often countries have resorted to using a foreign currency in an attempt to stabilize their economies.

In the past when inflation and in particular hyperinflation has become a problem investors have turned to precious metals and especially gold. Investors also look towards investing in real estate and commodities in difficult times.

TIPS, which are bonds issued by the US government and which have some protection against inflation are also worth considering in inflationary times. Their redemption value is related to the consumer price index.

However, if hyperinflation really takes off your best bet is gold bullion or coinage. Although it is expensive to accommodate gold and it will need to be insured, the price of gold will rise dramatically if hyperinflation becomes a major problem. When the price of gold rises then also the income for the gold mines rises and this in turn can help their stock price.

So it may be worth considering adding a mining company to your portfolio if you suspect hyperinflation is going to become a major concern.


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Are stocks like Citi, BOA, AIG, and GE good buys right now?

Why would you, as an independent investor, consider buying stocks like Citi, BOA, AIG, and GE? Of course their current stock values have never been lower. Well the only way is up, right? The management decks have been swept clean of the bad decision-making debris. The so-called toxic assets are guaranteed by the taxpayer through federal government bailout billions.

  • Citi or more properly Citigroup inc. of Park Avenue New York is one of America’s biggest banking corporations. The only way to judge whether this stock is a good buy in terms of current stock value and the direction it will move is to research. Turn to the Internet and your broker for real time information.
  • BOA or the Bank of America (BAC is it’s stock market code) was a highly valued stock in 2006 with a peak stock market valuation of $53 per share. Today you can buy a share for around $6. Is the only way up or are their assets now so bad that the only alternative is bankruptcy?
  • AIG or American International Group had a peak share value of over $73 at the end of 2006. Today the current stock value is under $1. A good buy? Public perception counts for a lot when it comes to current stock value and the outrageous bonus payments made to the failing employees of AIG may be enough to ensure that the only way is out for AIG. Out of private ownership and into government hands.
  • GE or General Electric Corporation is not in the financial sector of the New York Stock Exchange. It is what is known as a ‘general industrial’ stock but its current stock value is on the slide as with all stocks. 10% down against its peak.

Current stock value of any company is a two-sided coin. On the stock market side it is about financial ratios such as assets to liabilities, debt to capital, profit to turnover and dividends to investment.

On the other side of the current stock value coin are you, the buyer and your motivation for buying stocks. Do you want the stocks for pure speculation purposes? Are you looking for a quick kill or are you aiming for longer-term earnings above the rate of inflation perhaps or as an income in retirement. These stocks are uncertain when it comes to short-term profit but they are backed by the government and your tax dollars, to survive long into the future. So they are a better buy for the long-term earnings.


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Suze Orman, what exactly are your credentials?

I’ve been somewhat dumbfounded at the popularity of Suze Orman, since I posted an article about her on Larry King several months ago I continue to receive a ton of traffic. So, I started looking into the glimpse of stupidity I witnessed through her on Larry King to see that in fact, there is more to the story.  It seems this lady is pure marketing genius, without much in the form of credentials. It seems to me, someone handing out financial advice as often as she does should have some sort of eduction. However, looking everywhere for any mention of education proved futile. It seems, unless proved otherwise, she is strangling women all over the country with her words as truth, simply because she is a woman, rather than on any merit. That’s not to say that some of Suze’s common sense tips and advice aren’t all fine and dandy, and helpful to some or many – but they aren’t based on anything but her word.

I found an article written over 10 years ago at Forbes that highlighted this fact quite well.Evidently, anyone can call themselves a financial planner, without actually having to obtain any necessary licenses. This just goes to show, be wise and consider the source – even if they are an award winning author – it doesn’t mean they actually know what in the hell they are talking about or that you should listen to them.


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ERISA and your 401k; Employee Retirement Income Security Act


The Employee Retirement Income Security Act of 1974 (ERISA) (Pub.L. 93-406, 88 Stat. 829, enacted September 2, 1974) is an American federal statute that establishes minimum standards for pension plans in private industry and provides for extensive rules on the federal income tax effects of transactions associated with employee benefit plans. ERISA was enacted to protect the interests of employee benefit plan participants and their beneficiaries by requiring the disclosure to them of financial and other information concerning the plan; by establishing standards of conduct for plan fiduciaries; and by providing for appropriate remedies and access to the federal courts.

ERISA is sometimes used to refer to the full body of laws regulating employee benefit plans, which are found mainly in the Internal Revenue Code and ERISA itself.

Responsibility for the interpretation and enforcement of ERISA is divided among the Department of Labor, the Department of the Treasury (particularly the Internal Revenue Service), and the Pension Benefit Guaranty Corporation.

History

The history of ERISA can be said to have begun in 1961 when President John F. Kennedy created the President’s Committee on Corporate Pension Plans. The movement for pension reform gained some momentum when the Studebaker Corporation, an automobile manufacturer, closed its plant in 1963; the pension plan was so poorly funded that Studebaker could not afford to provide all employees with their pensions. The company created three groups. Group 1 consisted of 3,600 workers who reached the retirement age of 60. They got full pension benefits. Group 2 consisted of 4,000 workers, aged 40-59, who had ten years with Studebaker. They got lump sum payments that roughly equated to 15% of the actuarial value of their pension benefits. Group 3 was a residual group of 2,900 workers with no vested pension rights. They got nothing.

In 1967, Senator Jacob Javits proposed legislation that would address the funding, vesting, reporting, and disclosure issues identified by the presidential committee. His bill was opposed by business groups and labor unions, both of whom sought to retain the flexibility they enjoyed under pre-ERISA law.

A turning point in the history of ERISA came in 1970, when NBC broadcast Pensions: The Broken Promise, an hour-long television special that showed millions of Americans the consequences of poorly funded pension plans and onerous vesting requirements. In the following years, Congress held a series of public hearings on pension issues and public support for pension reform grew significantly.

ERISA was enacted in 1974 and signed into law by President Gerald Ford on September 2, 1974Labor Day. In the years since 1974, ERISA has been amended repeatedly.

Coverage

Pension plans

ERISA does not require employers to establish pension plans. Likewise, as a general rule, it does not require that plans provide a minimum level of benefits. Instead, it regulates the operation of a pension plan once it has been established.

Under ERISA, pension plans must provide for vesting of employees’ pension benefits after a specified minimum number of years. ERISA requires that the employers who sponsor plans satisfy certain minimum funding requirements.

ERISA also regulates the manner in which a pension plan may pay benefits. For example, a defined benefit plan must pay a married participant’s pension as a “joint-and-survivor annuity” that provides continuing benefits to the surviving spouse unless both the participant and the spouse waive the survivor coverage.

The Pension Benefit Guaranty Corporation was established by ERISA to provide coverage in the event that a terminated defined benefit pension plan does not have sufficient assets to provide the benefits earned by participants. Later amendments to ERISA require an employer who withdraws from participation in a multiemployer pension plan with insufficient assets to pay all participants’ vested benefits to contribute the pro rata share of the plan’s unfunded vested benefits liability.

Health benefit plans

ERISA does not require that an employer provide health insurance to its employees or retirees, but it regulates the operation of a health benefit plan if an employer chooses to establish one.

There have been several significant amendments to ERISA concerning health benefit plans:

  • The Health Insurance Portability and Accountability Act of 1996 (HIPAA) prohibits a health benefit plan from refusing to cover an employee’s pre-existing medical conditions in some circumstances. It also bars health benefit plans from certain types of discrimination on the basis of health status, genetic information, or disability.

Other relevant amendments to ERISA include the Newborns’ and Mothers’ Health Protection Act, the Mental Health Parity Act, and the Women’s Health and Cancer Rights Act.

During the 1990s and 2000s, many employers who promised lifetime health coverage to their retirees limited or eliminated those benefits.[1][2] ERISA does not provide for vesting of health care benefits in the way that employees become vested in their accrued pension benefits. Employees and retirees who were promised lifetime health coverage may be able to enforce those promises by suing the employer for breach of contract, or by challenging the right of the health benefit plan to change its plan documents in order to eliminate those promised benefits.

Pension vesting

Before ERISA, some defined benefit pension plans required decades of service before an employee’s benefit became vested. It was not unusual for a plan to provide no benefit at all to an employee who left employment before retirement (age 65 or perhaps age 55), regardless of the length of the employee’s service.

As of 2007, employees’ benefits in a defined benefit pension plan must become vested at 100% after five years or under a seven-year graded-vesting schedule (20% a year for each year of service beginning with the third year of service and ending with 100% after seven years).

Under the Pension Protection Act of 2006, employer contributions made after 2006 to a defined contribution plan must become vested at 100% after three years or under a six-year graded-vesting schedule (20% a year for each year of service beginning with the second year of service and ending with 100% after six years). Different rules apply with respect to employer contributions made before 2007. Employee contributions are always 100% vested.

Pension funding

Under ERISA, minimum funding requirements were established for defined benefit plans. By their nature, defined contribution plans are always fully funded, even if the employee has not yet become vested in the employer contributions.

Before the Pension Protection Act (PPA), a defined benefit plan maintained a “funding standard account”, which was charged annually for the cost of benefits earned during the year and credited for employer contributions. Increases in the plan’s liabilities due to benefit improvements, changes in actuarial assumptions, and any other reasons were amortized and charged to the account; decreases in the plan’s liabilities were amortized and credited to the account. Every year, the employer was required to contribute the amount necessary to keep the funding standard account from falling below $0 at year-end.

In 2008, when the PPA funding rules went into effect, single-employer pension plans no longer maintain funding standard accounts. The funding requirement under PPA is simply that a plan must stay fully funded (that is, its assets must equal or exceed its liabilities). If a plan is fully funded, the minimum required contribution is the cost of benefits earned during the year. If a plan is not fully funded, the contribution also includes the amount necessary to amortize over seven years the difference between its liabilities and its assets. Stricter rules apply to severely underfunded plans (called “at-risk status”).

The PPA has different funding requirements for multiemployer pension plans, which preserve most of the pre-PPA funding rules including the funding standard account. Under PPA, increases and decreases in the plan’s liabilities will be amortized, but the amortization period for benefit improvements adopted after 2007 will be shortened. As with single-employer plans, multiemployer pension plans that are significantly underfunded are subject to restrictions. The restrictions, which may limit the plan’s ability to improve benefits or require the plan to reduce employees’ benefits, vary depending whether a pension plan’s funding status is termed “endangered”, “seriously endangered”, or “critical”. The restrictions accompanying each deficient funding status are progressively more severe as funding status worsens.

ERISA pre-emption

ERISA Section 514 preempts all state laws that relate to any employee benefit plan, with certain, enumerated exceptions. The most important exceptions — i.e. state laws that survive despite the fact that they may relate to an employee benefit plan — are state insurance, banking, or securities laws, generally applicable criminal laws, and domestic relations orders that meet ERISA’s qualification requirements.

A major limitation is placed on the insurance exception, known as the “deemer clause”, which essentially provides that state insurance law cannot operate on employer self-funded benefit plans. The Supreme Court has created another limitation on the insurance exception, in which even a law regulating insurance will be pre-empted if it purports to add a remedy to a participant or beneficiary in an employee benefit plan that ERISA did not explicitly provide.[3]

Hawaii Prepaid Healthcare Act exemption

ERISA contains an exemption specifically regarding the Hawaii Prepaid Healthcare Act, which was enacted by that state a few months before ERISA was signed into law. As a result, private employers in Hawaii are bound by the rules of that state law in addition to ERISA. The exemption also freezes the law in its original 1974 form, meaning the Hawaii legislature is not able to make non-administrative amendments without Congressional approval.[4][5]

The Statute

Title I: Protection of Employee Benefit Rights

Title I protects employees’ rights to their benefits. The following are some of the ways in which it achieves that goal:

  • Participants must be provided plan summaries.
  • Employers are required to report information about the plan to the Labor Department and provide it to participants upon request. The information is reported on Form 5500, which is available for public inspection and may be viewed at websites such as freeERISA.com and Free5500.com.
  • If a participant requests, the employer must provide the participant with a calculation of her or his accrued and vested pension benefits.
  • Employers have fiduciary responsibility to the participants and to the plan.
  • Certain transactions between the employer and the plan are prohibited.
  • A pension plan is barred from investing more than 10% of its assets in employer securities.

Title I also includes the pension funding and vesting rules described above.

Title II: Amendments to the Internal Revenue Code Relating to Retirement Plans

Title II amended the Internal Revenue Code (IRC). The changes include the following:

  • The addition of various requirements for a pension plan to be tax-favored (“qualified”), including:
    • the plan must offer retirees the option of a joint-and-survivor annuity,
    • benefits under the plan may not discriminate in favor of officers and highly-paid employees,
    • and plans are subject to the pension funding and vesting rules described above.
  • The imposition of maximum limits on the annual benefit that may be paid from a qualified defined benefit pension plan and the annual contribution that may be made to a qualified defined contribution pension plan.
  • Revision of the rules concerning the maximum tax deduction allowed with respect to a contribution to a pension plan.
  • The imposition of an excise tax if the employer fails to make a required contribution to a pension plan or engages in transactions prohibited by ERISA.

Title III: Jurisdiction, Administration, Enforcement; Joint Pension Task Force, Etc.

Title III outlines procedures for co-ordination between the Labor and Treasury Departments in enforcing ERISA.

It also created the Joint Board for the Enrollment of Actuaries, which licenses actuaries to perform a variety of actuarial tasks required of pension plans under ERISA. The Joint Board administers two examinations to prospective Enrolled Actuaries. After an individual passes the two exams and completes sufficient relevant professional experience, she or he becomes an Enrolled Actuary.

Title IV: Plan Termination Insurance

Title IV created the Pension Benefit Guaranty Corporation (PBGC) to insure benefits of participants in underfunded terminated plans. It also describes the procedures that a pension plan must follow in order to terminate.

Single-employer plans

Standard termination

An employer may terminate a single-employer plan under a standard termination if the plan’s assets equal or exceed its liabilities. If the assets are less than the liabilities, the employer must contribute the amount necessary to fully fund the plan. A standard termination is sometimes referred to as a voluntary termination because the employer has chosen to terminate the plan.

In a standard termination, all accrued benefits under the plan become 100% vested. The plan must purchase annuity contracts for all participants. If the plan permits the payment of lump sums, employees may be offered the choice of a lump sum payment or an annuity.

If any assets remain in the plan after a standard termination has been completed, the provisions of the plan control their treatment. In some plans, the excess assets revert to the employer; in other plans, the excess assets must be used to increase participants’ benefits.

Distress termination

An employer may terminate a single-employer plan under a distress termination if the employer demonstrates to the PBGC that:

  • the employer is facing liquidation under bankruptcy proceedings,
  • the costs of continuing the plan will cause the business to fail, or
  • the costs of continuing the plan have become unreasonably burdensome solely because of a decline in the employer’s workforce.

If the PBGC finds that a distress termination is appropriate, the plan’s liabilities are calculated and compared with its assets. Depending on the difference between the two values, the termination may be treated as if it had been a standard termination or as if it had been initiated by the PBGC.

Termination initiated by the PBGC

PBGC may initiate proceedings to terminate a single-employer plan if it determines that:

  • the employer has not made its minimum required contributions to the plan,
  • the plan will not be able to pay benefits when due, or
  • PBGC’s long-term cost can be expected to be unreasonably higher if it does not terminate the plan.

A termination initiated by the PBGC is sometimes called an involuntary termination.

The benefits paid by the PBGC after a plan termination may be less than those promised by the employer. See Pension Benefit Guaranty Corporation for details.

Multiemployer plans

A multiemployer plan may be terminated in one of three ways:

  • It may be amended so that participants receive no credit for future service,
  • All contributing employers may withdraw from the plan or stop making contributions to it, or
  • It may be converted into a defined contribution plan.

Non-ERISA status and bankruptcy

In 2005, Public Law 109-8[1] amended the Bankruptcy Code, by exempting most organised retirement plans, even those not subject to ERISA, and accorded them protected status, claimable as exempt property by a debtor declaring bankruptcy under the U.S. Bankruptcy Code.

Now, most pension plans have the same protection as an ERISA anti-alienation clause giving these pensions the same protection as a spendthrift trust. The only remaining unprotected areas are the SIMPLE IRA and the SEP IRA. The SEP IRA is functionally similar to a self-settle trust, and a sound policy reason would exist to not shield SEP IRAs, but many financial planners argue that a rollover (or direct transfer) from a SEP IRA to a rollover IRA would give those funds protected status, too.

Finding statutes

Portions of ERISA are codified in various places of the United States Code, including 29 U.S.C. ch.18, and Internal Revenue Code sections § 219 and § 408 (relating to the Individual Retirement Account) and sections § 410 through § 415, and § 4971, § 4974 and § 4975. A cross-reference between the sections of the ERISA law and the corresponding sections in the U.S.Code can be found at http://www.harp.org/erisaxref.htm.

See also

External links

Footnotes

  1. ^ Costello, Daniel (October 18, 2004). “Not a future they expected“. Los Angeles Times. Archived from the original on 2004-10-19. Retrieved on 2008-04-12.
  2. ^ Schultz, Ellen E. (November 10, 2004). “Companies Sue Union Retirees To Cut Promised Health Benefits“. The Wall Street Journal p. 1. Retrieved on 2008-04-12.
  3. ^ Aetna Health Inc. v. Davila, 542 U.S. 200 (2004)
  4. ^ Hawaii Institute for Public Affairs. “Prepaid Health Care Act“. Retrieved on 2007-11-08.
  5. ^ Cornell University Law School. “§ 1144“. Retrieved on 2007-11-08.


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What does it cost for a small business to start their own 401k

A reader wrote in with some good questions about starting up a 401k for their small business. Shelly wrote the following (edited for clarity):

Hi, Mark,
I have two C corporations, one has employees from time to time, and another has no
other employees except myself. I am thinking about setting up a 401k for the one
which there are no employees in it. My questions are:
1) Is it permissible and economical for a company to setup a 401k plan when it
only has one employee?
2) If so, what is the procedure in doing so?

Thank you in advance for your help.

———————————————————

Hi Shelly,

I am happy to try and help you. In doing so, I will take some guesses as to what you are getting at, and try and answer that for you. In addition, I will provide some options for those in similar situations, which may include yourself.

First question you had was:

1) Is it permissible and economical for a company to setup a 401k plan when it
only has one employee?

I’m really wondering what you’re asking me Shelly:

So I’ll break your question into two answers, I’ll answer is it ethical, legal and smart for your business to setup a 401k plan for one person, the owner. Next, I’ll tell you if the same is true for an owner of a small business to offer a 401k plan to just one employee, or two, or even more.

To answer your question, we need to setup some basic assumptions though. To see if something for a small business is economical, you need to know what you can afford. For example, for one employee, your annual fixed cost would be no more than an $800 setup fee, and no more than $500 for administration fees, or $1,300 in total fixed. Now, say you offered an average %5 match to the employee, who made $30,000 a year, it would cost another $1,800 per year. So, for that one employee, the cost would be $3,100 to your business per year. Is it worth it? That maybe too hefty a cost for you, or not. If you as an owner are doing this for yourself, I would say you are wasting half of that money in fees, when you can go to a bank and setup a personal IRA, and do the same thing without paying all the fees. Now, if it were for an employee, it maybe a different situation, where you’ll have to compare costs to what you’re getting in return. You would have to tell me.

Now, to answer if it is smart for a single employee or more, here you go. I could tell you that employees are attracted and retained by that offer. It just depends if it is worth it to you and your business. The fixed cost for having up to 50 employees won’t cost more than an $800 setup fee and $2,500 and admin charges, plus match amount times their salary.

Some examples of the different plans available to you include the “Individual(k)”, “Solo 401(k)”, “Uni-K Plan”, “Self-Employed 401(k)”, SBO-401(k), and various others like Keogh plans. Your business is eligible for them all. Not to mention, explore your own options in investing in an IRA through your local bank or investment company.

Something to keep in mind, you do have tax savings to the business that counter those costs, which may help you recover 20% or so of those costs.

These options apply to you as an owner wishing to establish a savings plan for yourself, and or for an employee. They are not only legal and ethical, they are smart if cost effective. Although, without putting the numbers together, nobody could tell you.

How do you do it? You have a number of options: Check them all out for your best price, if it is for an employee.

For the small business owner interested in looking into the benefits of offering a 401k for your employees as a recruitment and retention tool check out:ShareBuilder 401(k) . It’s completely free to get a quote, and there are numerous tax benefits for your company (even if it is only for you).

http://www.401k-easy.com/prices/ is another one found on an easy google search. Try the same and you will find many other options.

If you are doing it for yourself, go setup an IRA or Roth IRA at your local bank or investment bank. They can easily help direct you.

Good luck, and keep asking away.

Your trusty accountant,

Mark


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My work is going bankrupt, what will happen to my 401k and benefit plan?

401(k) plans are tax-qualified plans covered by ERISA such that assets held by the plans are generally protected from creditors of the account holder, which in the past was generally not true for IRA plans. In the case of employer bankruptcy, all 401(a) (pension and defined contribution plans) and 401(k) plans are protected, because of the rule that contributions must accrue to the exclusive benefit of employees in general. Even though pension plans are backed by insurance through the Pension Benefit Guaranty Corporation, workers whose company enters bankruptcy may not receive the full value of their pension. ERISA protection of 401(k) assets does not extend to losses in the value of investments that participants choose. Employees investing their 401(k) in their own employer stock face the possibility of losing the value of their retirement accounts that is invested in employer stock along with their jobs if their employer goes out of business.


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401k balance

A cash balance plan is a defined benefit retirement plan that maintains hypothetical individual employee accounts like a defined contribution plan. The hypotheticality of the individual accounts was crucial in the early adoption of such plans because it enabled conversion of traditional plans without declaring a plan termination.

Basics

The employees’ accounts earn a fixed rate of return that can change over a period of time from year to year. Although it works much like a defined contribution plan, it is actually a defined benefit plan for legal purposes. In 2003, over 20% of workers with defined benefit plans were in cash balance plans, according to Bureau of Labor Statistics data. Most of these plans resulted from conversions from traditional defined benefit plans. However the status of such plans is currently in legal limbo due to court decisions (see below), and the number of conversions has slowed. Congress was considering legislation to clarify the status of cash balance plans and there is legislation which would permit the moratorium on new conversions to end.

Conversion controversy

Cash balance conversions have been controversial and have raised the ire of workers and their advocates. In 2005 the Government Accountability Office (GAO) released a report analyzing the effects of cash balance conversions on worker benefits. They found that in a typical conversion the cash balance plan would provide lower benefits for most workers than if the defined benefit plan had remained unchanged and the worker had stayed in their job until retirement age. This decline in benefits tends to be largest for older workers. This is because in a traditional plan, where benefits are based on final average pay, the “value” of the benefits accrues much faster for older workers than for younger workers. In contrast, in a DC or cash balance plan, all workers contribute at the same rate, and a dollar contributed by a younger worker is actually more valuable because it has more time to compound before retirement. Thus some argue that cash balance plans hurt workers.

On the other hand, this may not be the relevant comparison. If the alternative to cash balance conversion is that the plan is frozen or terminated (with the vested balance going to the worker), all workers would be much worse off than in a cash balance conversion. This is a realistic possibility; tens of thousands of defined benefit plans have been frozen and/or terminated in the last two decades, far more than have been converted to cash balance plans. Likewise, for the many employees who leave their job before retirement (whether voluntarily or not), many would be better off under the cash balance conversion than under the original defined benefit plan. In addition, about half of cash balance conversions have grandfathered in some or all of the existing participants in the defined benefit plan.

Types of pensions

The ubiquitous 401(k) plan is an example of a defined contribution plan because the Internal Revenue Code §414(i) states [t]hat the term defined contribution plan means any plan that provides retirement benefits to a worker based solely on the amount contributed to the (worker’s individual) account and any (investment) income, gains net of any expenses and losses.

Under the definition of accrued benefit under Code §411(a)(7)(ii) in the case of a plan that is not a defined benefit plan, [the term accrued benefit] means the balance [in] the employee’s [individual] account. On the other hand for defined benefit plans, Section §411(a)(7)(i) states that “accrued benefit” means “the employee’s [] annual benefit” as it is “determined under the plan … expressed in the form of an … [annuity] … commencing at normal retirement age.” Finally, the Code’s definition for defined benefit plans are all plans that are not defined contribution plans.

Cash balance plans are defined benefit plans that look like defined contribution plans. A worker’s right to a pension in a defined benefit plan represents a contingent and hence uncertain financial obligation to the employer sponsoring the plan. Section 412 of the Code requires the employer to make annual contributions to the plan to ensure that the plan assets will be sufficient to pay the promised benefits later at retirement. As part of this process the plan is required to have an actuary perform annual “actuarial valuations” in which the present value of each worker’s “accrued benefit” is estimated and then each present value for each worker covered by the plan is added up so that the minimum annual contribution can be determined.

The “actuarial present values” for the “accrued benefit” for each worker is the lump sum dollar amount that represents the financial value of the employer’s liability on the date of the valuation. It does not include the future accrual of pension benefits nor does it include the effect of projected future salary increases. Thus the lump sum value for each worker is not based on that worker’s projected final salary at retirement, but only the worker’s salary on the date of valuation.

Design of plans

Some cash balance plans communicate to workers that these “actuarial present values” are “hypothetical accounts” because upon termination of service, the employer will give the former worker the option to take “all his money” from the pension plan out. In reality, if both the worker and employer agree, even in a normal defined benefit plan a former worker may take away “all his money” from the pension plan. There are no legal differences in this “portability” aspect between a traditional defined benefit plan and a cash balance plan.

A typical “design” for a cash balance plan would provide each worker a “hypothetical account” and pay credits in the current year of say 5% of current salary. In addition, the cash balance plan would provide an interest credit of say 6% of the prior year’s balance in each worker’s “hypothetical account” so that the current year’s balance would be the sum of the prior year’s balance and the current year’s pay credit and an interest credit on prior year’s balance. For a worker who starts at age 25 with a $2000 a month starting salary, he would start with a zero account balance and the first year’s pay credit would be $1200 leaving him with an end of first year balance of $1200 in his “hypothetical” account. Because his beginning of first year balance was zero, his interest credit for the first year is also zero. In his second year, with a 3.5% salary increase his monthly salary would be $2070 on his 26th birthday. The 5% pay credit for this second year would be $1242. Because his second year “hypothetical account” starts the year with a $1200 balance, the interest credit at 6% would be $72. Adding the beginning balance of $1200 to the $1242 pay credit and $72 interest credit would give an ending balance in the “hypothetical” account of $2514 ($2514 = $1200 + $1242 + $72) for the second year. Repeat this process for each ensuing year until termination. This creates a hypothetical account balance from which the legally required benefit — an annuity payable for the life of the participant or beneficiary who elects to commence payment at normal retirement age(NRA) — can be calculated. This is due to requirement that benefits be definitely determinable found in the IRS Regulations Section 1.401.

Lump sum calculation cases

In 1993, the Third Circuit decided in Goldman v. First National Bank of Boston that the terminated worker did not demonstrate that the adoption of the cash balance plan violated age discrimination rules. In 2000, the Eleventh Circuit in Lyons v. Georgia Pacific and the Second Circuit in Esden v. Bank of Boston decided that the employer violated rules for calculating lump sums, and a district court in Eaton vs. Onan Corp. decided that adopting the cash balance plan did not violate age discrimination rules. In early 2003, the First Circuit in Campbell v. BankBoston did not decide that the employer violated the age discrimination rules against a former worker because the former worker made a procedural error and brought the issue up late.

Then in summer of 2003, the Seventh Circuit in Berger v. Xerox Corp. Retirement Plan, decided that the lump sum calculation for workers terminating service prior to retirement who were covered by the defendant cash balance pension plan cannot violate the rules for defined benefit plans and in a district court in Illinois in Cooper vs. IBM Personal Pension Plan, decided that the very design of the cash balance plan – the issue that the Campbell court only reached in dicta – had indeed violated the age discrimination rules because the “rate of benefit accruals” did “decrease” on account the “attainment of any age.”

The Lump Sum cases all held that because cash balance plans were defined benefit plans, they had to abide by the rules for defined benefit plans when the employer calculates the lump sum actuarial present value by first accruing the account balance to normal retirement age and then converting the account balance at retirement age into a life annuity before then discounting back to the current date. Because these cash balance plans were designed to “look like” defined contribution plans, the defendants asserted that these cash balance pension plans were not true defined benefit plans but were “hybrid” plans instead. Therefore, because, they were “hybrids” and looked like defined contribution plans and because workers are only entitled to the actual balance in defined contribution plans, the plaintiffs should get lump sums equal only to their “hypothetical” account balances. In Berger v. Xerox, Judge Richard Posner in a stinging phrase – “for hybrid read unlawful” – held that the lump sum amounts should have been larger. So the cash balance plan is not an exotic “hybrid” plan in the eyes of the law but remained in the defined benefit part of the pension taxonomy.

This process of taking the account balance forward from the terminated worker’s current age up to the worker’s normal retirement age, before discounting back to the current age is sometimes called the “whipsaw.” If the interest rate used for discounting back is lower than the rate used for interest credits on the hypothetical account balances, then the legally required lump sum values would be higher than the worker’s account balance in his hypothetical account.

The age discrimination cases

Age discrimination is not the US pension law’s highly compensated employee nondiscrimination which requires that any plan which covers both highly compensated employees and non-highly compensated employees.

Proponents of cash balance plans advocate that these plans do not violate the age discrimination statutes applicable to defined benefit pension plans. The statutes forbid – in virtually the same words – any plan from reducing “the rate of benefit accrual” for any worker on account “of the attainment of any age”.

Although the Code defines the “accrued benefit” for any worker covered by defined benefit plans as “expressed in the form of an annual benefit commencing at normal retirement age” and defines “normal retirement benefit” as the “greater of the early retirement benefit under the plan, or the benefit under the plan commencing at normal retirement age”, the supporters of such cash balance plans still argue that the terms “accrued benefit” and “rate of benefit accrual” are ambiguous or undefined.

In Onan Corp., District Court Judge Hamilton agreed with the supporters of cash balance plans and held that the cash balance plan design did not violate age discrimination because the terms “rate of benefit accrual” and “accrued benefit” were not defined in the relevant statutes. He then engaged in an exercise of statutory construction that Professor Edward Zelinsky found fault with. But the terms “accrued benefit” and “rate of benefit accrual” have long been very familiar and unambiguous to pension actuaries. It was because the terms were so unambiguous to actuaries that they could construct the initial balances in each worker’s “hypothetical” account for these new cash balance pension plans. Also, §411(a)(1)(7) of the Code defines “accrued benefit”. Thus pension actuaries are very familiar with changes in accrual rate factors used in a traditional defined benefit pension plan’s formula.

In Cooper, District Court Judge Murphy came to the opposite conclusion because to him, the terms accrued benefit and rate of benefit accrual were not ambiguous. Because benefits accrued at a decreasing rate solely based on increases in age, the plan design of the cash balance plan violated the age discrimination statutes. If this rule is upheld, then all “flat rate pay credit” design cash balance plans would violate age discrimination. A plan sponsor could avoid these problems by setting up a cash balance plan with steadily increasing – or age graded – rates for pay credits. This has the same economic effect as adopting a “career average salary” traditional defined benefit plan. Murphy has just been reversed! [1]

Legislative developments

Because of the troublesome age discrimination suits and misunderstanding and frustration by older workers covered by such plans, Congress, notably Senator Charles Grassley (R) of Iowa, has a proposal to statutorily fix the problem. It involves outlawing “wearaway”.

The Pension Protection Act of 2006 was signed into law in August 2006 and prospectively made the flat salary credit type plans immune from age discrimination. Also the use of a higher interest rate for calculation of lump sums is now allowed as the new law eliminates the whipsaw. The act only fixes age discrimination prospectively.

All of the above was found here.


Suze Orman; “The money just vanished”


Last night, 9/29/08, Larry King asked “internationally acclaimed personal finance expert” Suze Orman many questions about the losses on wall street. One particular question and response from the expert made me thoroughly confused, it went a little something like this: Larry speaking.. “We lost something to the tune of 1.2 trillion dollars in the stock market today, where did it go Suze?”

Suze responds with somewhat of a dumbfounded look (if that isn’t her typical look – I’m not sure, really) “It Vanished Larry, yep poof, gone forever.” Now, you have a personal finance expert telling people that the money just disappeared, like some sort of Colombo mystery. Well Suze, people that held onto the stocks may have lost money – but it didn’t just float away. People sold off their shares and took their funds back out of the stock market, to the tune of 1.2 trillion dollars, it didn’t simply vanish, it exchanged hands from the market to the investors. I understand people can’t and won’t know everything, I sure as hell don’t, but what I don’t think should be done; is act like you know and give ignorant answers.

On a side note, Ben Stein (another annoying turd) had an interesting point about the impending credit swap crisis.


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What are our options beside this $700 billion dollar bailout?


Many prominent economists are looking at history for a bit of guidance versus making an illogical, irrational, fear based decision that may create an potentially larger financial problem. How have other countries whom faced similar crisis’ handled their problems? Sweden seems to be the glaring example of another country whom has faced a similar situation to our own in the early nineties. Below is how they handled the situation and why it is likely better than providing the government with nearly a trillion dollars in discretionary spending financed on the general public’s back.

Sweden and their situation: “Newly deregulated credit markets after 1985 stimulated a competitive process between financial institutions where expansion was given priority. Combined with an expansive macro policy, this contributed to an asset price boom. The subsequent crisis resulted from a highly leveraged private sector being simultaneously hit by three major exogenous events: a shift in monetary policy with an increase in pre-tax interest rates, a tax reform that increased after tax interest rates, and the ERM crisis. Combined with some overinvestment in commercial property, high real interest rates contributed to breaking the boom in real estate prices and triggering a downward price spiral resulting in bankruptcies and massive credit losses. The government rescued the banking system by issuing a general guarantee of bank obligations. The total direct cost to the taxpayer of the salvage has been estimated at around 2 per cent of GDP.” (1)

Wait, this sounds like what we’re doing doesn’t it? Yes, very similar, however, instead of simply pumping in dollars to help the companies pay their bills, the Swedish Government forced the banks to sell off their assets to help meet current bills and drain down shareholder value. Basically, they made the shareholders of the companies take a complete loss before allowing the bank to get aid. So, whatever money the government put in was completely owned by the public through their government. When the banks stabilized and eventually began to turn profits again, the government sold back shares to the public. Whatever they made went against the debt they had incurred.

So, how is this different again then what we’re trying to do? The current proposals on the house floor more or less reward the shareholders of the banks (or insurance company or whatever industry we’re talking about that is proposed to recieve aid) at the cost of the general public versus first forcing the company shareholder to lose their interest. In other words, if you don’t make the true shareholders lose their interest, they stand to benefit twice. This is especially unnerving when it comes to seeing the way those executives prospered in the form of salaries and bonuses off of fake profits in the first place.

Not to mention: Our current proposal, compared to Sweden’s, will cost around 3% more. The Swedish government reassurance in its backing of the financial industry helped curb the runs on banks and unwarranted devaluations of similar company stocks that had little fundamental problems simply because of a credit crunch.

Coming to a theater near you: Credit Card default swaps will be the next mortgage crisis

(1) “The Swedish banking crisis: roots and consequences,”  P Englund
Stockholm School of Economics, Stockholm, Sweden


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Black Monday – Part III


The first true Black Monday occurred at the beginning of the Stock Market Crash of 1929. The second one occured some 21 years ago, in 1987. Today, could arguably be coined Black Monday – Part III, however, it doesn’t even compare to the one day loss of 23% in 1987 or the lesser one day loss in 1929. How long did recovery for the two prior Mondays take?  Actually, the 1987 stock market ended the year higher even though they had such an anomally. The 1929 crash however, took much longer to recuperate from, in fact, nearly 25 years.


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