Overview
We lived in politically charged times. Congress seems unable to reach any consensus on anything including where to have the annual Congressional Christmas Ball! Years of political crossfire over the Affordable Care Act have drawn renewed focus on employee benefits in general. If the current administration thought that healthcare and the problem of the uninsured was a national crisis, then the subject of employee retirement plans has to be a problem of even greater magnitude. The topic of retirement benefits has only been on the media radar peripherally as a result of large scale municipal bankruptcies and the potential impact on retiree benefits and the esoteric topic of pension underfunding.
The reality is for most people do not have the financial resources to retire at the traditional retirement age of 65 and will continue working until their death. The problems are exacerbated by a combination of other factors – complex regulations under ERISA and the Internal Revenue Code – which require the employer to satisfy a number of participation and contribution requirements; a weak economy and higher marginal tax rates. When it is not attractive and personally beneficial for the Boss Man to add a benefit program, the result is very simple. No one gets a pension plan.
It is ironic that that public sentiment over labor unions is generally negative; however, the days of heavy manufacturing and union organizing in the U.S. (say the 19050’s-1970’s), seem to be the last time that American workers had secure retirement benefits. This article is a personal observation of pension benefits in small business relative to the very generous pension benefits through public pension plans – federal, state and municipal. The point is that in retrospect public service may not have been such a bad way to go- good hours; good benefits; and job security. Corporate America is the last twenty five years has proven to be anything but that. Yes, some people got very rich as a result of restricted stock and stock options.
The article references once again the idea that a business owner needs something to level the playing field after considering ERISA and tax law requirements. The business owner’s best friend may turn out to be the least likely of partners – labor unions.
As the popular cliché states, politics (and high taxation) make strange bedfellows.
An Overview of Retirement Trends in the United States – A Not So Pretty Picture
It seems as if the normal retirement age of 65 has been changed to the earlier of age 95 or death. My focus is on small business retirement plans. Why? According to the Small Business Administration (SBA), small businesses (defined as having fewer than 500 employees) account for 55 percent of all jobs in the U.S. economy. The SBA states that as of 2013 that there are 23 million small businesses that account for 54 percent of all U.S. sales while providing 55 percent of all jobs in the U.S. economy. The 600,000 small business franchises have created 8 million jobs while accounting for 40 percent of all retail sales.
As of 1990,”Big Business” in its trend towards “offshoring” and efficiency, eliminated 4 million jobs while small businesses added 8 million jobs. A middle aged taxpayer in corporate middle management working for “Big Business” has a very high chance of becoming an “accidental” small business owner.
I have never thought of myself as a cynic but if you are a middle aged middle manager, your days working for a large corporation are probably number in case you haven’t already gotten your Pink Slip. It used to be that big business meant job security, a new watch and secure retirement at age 65. These days it seems impossible to remain with a single employer for an entire working career regardless of job performance.
A high percentage of the small businesses – 78 percent- according to Forbes Magazine have no additional employees or payroll. Over 50 percent of the working population works in a small business with a high percentage 52%) being home-based.
Over the last thirty years or so following the adoption of ERISA in 1974, retirement plan trends have changed dramatically. According to a Treasury Inspector General report on retirement trends, the last forty years have seen a dramatic shift in participation but an equally dramatic shift in pension funding from employers to individual participants. Between 1977 and 2007, 401(k) participation increased 358 percent while defined benefit participation decreased 31 percent.
As a matter of fact, defined benefit plans represent only nine percent of qualified plan arrangements in small business. However, only forty four percent of the small businesses with fewer than fifty employees has any type of retirement plan in place. The average defined benefit accrued benefit for defined benefit participants as of 2007 was $62,000. The average defined contribution benefit for defined contribution plans was $42,000 in 2007 before the recession. Meanwhile, only eight percent of the working population has an Individual Retirement Account (IRA) in place.
According to testimony before the U.S. Senate Special Committee in April 2010, fifty percent of Americans within ten years of retirement had on average financial assets of $72,000 in 2007 before the economic downturn which was roughly equivalent to the median income in the same year. According to government actuarial statistics, for a couple aged 62, has a 47percent chance of one of them will survive until age 90.
If I Knew Then What I know Now!
As the cliché goes, “Hindsight is 20/20!” I have never been one to lament the road traveled versus the road less traveled. However, having experienced the military, corporate America, and self-employment, I can make a few observations. First, the likelihood of being able to spend a career with a single employer (even if you want to) is slim-to-none. As a result, participation in the company’s pension plan over a career is highly unlikely if they have one. Second, over the course of that career, there is a pretty good chance that your employer would have been acquired by a competitor or your employer would have reduced their level of contribution to cut costs at the suggestion of some consultant. Third, employers have squeezed by the economic turmoil and have dramatically shifted the costs of benefit programs including retirement to employees with a little bit of matching contribution if you are lucky.
Contrast these statistics with employees that are state and municipal workers. Over 90 percent of state and municipal workers are still covered by defined benefit plan. 8.8 million employees are covered under the federal government pension plan with $930 billion in plan assets as of 2007. At the same time 2,547 state and municipal plans with $3.4 trillion in assets providing defined benefit benefits of 18.6 million participants. In the spirit of author and marketing professor Tom Stanley’s The Millionaire Next Door, it would appear that the neighbor who works for state or municipal government, is a millionaire as a result of his pension benefits. How can that be?
According to the National Center of Policy Analysis, the average pension benefit for public workers in Nevada is $64,000 per year; $60,420 in Colorado and $61,500 in California. The union for state and municipal workers (American Federation of State, County and Municipal Employees (AFSCME)) claims that the average pension benefit is only $19,000. The present value of benefits discounted at 3.5 percent for a California retiree, age 60, with a 21.5 year life expectancy, is $910,000. State and municipal workers enjoy retirement benefits that are 72-89 percent higher than workers in private industry. The key is the defined benefit plan retirement plan approach. How does private industry equalize the disparity?
Assume that you a fireman in the Heartland and joined the fire department after getting out of the Army at age 22. At age 55, the normal retirement age, your highest 36 month average if $80,000. The projected single life annuity is $48,000 per year. Based on a life expectancy of 25.5 years, the present value of benefits without assuming any increase of the pension benefit of the Consumer Price Index, at a discount rate of 3.5 percent is $810,737. Life expectancy is defined as the actuarial probability of death being fifty percent at a given age.
Assuming an additional ten years of life, the present value jumps to $960,000. He also accumulated an additional $1 million in the municipality’s 403(b) plan. Our fireman worked two days per week on average over his career, and operated a landscaping business as well. Over the course of twenty five years, he accumulated an additional $750,000 in a profit sharing plan within his landscaping business. At age 62, his projected social security benefit is an additional $24,000 per year. Our fireman will continue to operate his landscaping and snow removal business in retirement.
The statistics do not paint a pretty picture. Most American are poised to outlive their resources. More and more Americans are finding themselves employed by small businesses that do not offer participation in a qualified retirement plan. If they do, it is likely that the plan is a 401(k) without an employer match or a minimal contributions. Business owners are reluctant to add plans due to the cost of contributing for employees without enough perceived benefit for the business owner. One of the inadvertent effects of pension regulation as a result of ERISA and tax law is that if the business owner does not reap enough personal reward then nobody gets a pension plan.
You might conclude that being a fireman is a great job (until there is a fire) but my mother and father both retired at my current age with comfortable retirements from the federal government like our fireman. Given the level of underfunding of state and municipal pension plans, it remains to be seen whether these type of public employers can continue. Corporate jocks might be well served to look a government employment. College graduates may also do well to look at government employment. However, the government employee like the fireman in our example would be well served to incorporate outside business activity as part of the employment mix. The combination of revenue sources and benefit programs will produce long term security and deferred compensation.
The Union Exemption
I have previously written about the powerful exemption from the pension minimum participation rules in IRC Sec 410(b) (3)(A). Every pension plan document since the dawn of ERISA has referenced this exemption while every business owner has snickered and snubbed this golden opportunity. For example, the professional service business owner (medical doctor, engineer, architect, chiropractor, lawyer, and accountant) that requires state or federal licensing to operate, would be very hard pressed to imagine a scenario where Jimmy Hoffa comes back from the dead to wrestle control of the business from the business owner. The bottom line is that the use of this exemption will allow the business owner to incorporate a defined benefit plan without including the employees in the Plan. The trick is finding the right union partner.
Summary
With the coveted defined benefit plan almost extinct, access to a comfortable retirement has also disappeared. Along with cost-cutting and transferring jobs overseas, companies have shifted the cost of benefit programs and retirement to employees. Qualified retirement plans remain one of the most legitimate mechanisms for reducing and deferring current income. Small business owners can regain control over their future retirement by intelligently considering the implications of the union exemption. College students and displaced corporate workers might take a look at government service in order to lock in long term service with a twist. The twist is this. Workers should become entrepreneurs to some degree and create additional sources of revenue outside of their fulltime employment. These entrepreneurial activities aside from creating additional income will create income reduction and deferral strategies. Absent the utilization of techniques such as the one referenced in this article, workers and business owners will face a retirement age that is more likely to be the “earlier of age 95 or the participant’s passing.”
