Personal Wealth Law News

Schadenfreude is the German word for taking pleasure in someone else’s misfortune. Like when someone speeds by you on I-95 and a few miles later, you see him pulled over by a state trooper. Schadenfreude. I have read numerous articles in the past week detailing the losses of leaders of large bank and investment firms. The New York Times of September 22 had a chart showing before and after stock ownership values for the heads of several of large institutions in the news. The numbers were so large before that it’s hard to escape the feeling that it was too much, but it’s difficult to understand how the “after” numbers were reached so quickly.

It’s not possible to have the same feeling about the thousands of employees who were also invested in stock of their employers, either outright or through retirement accounts. For many of those people, plans for retirement and post-retirement, including estate planning, have been destroyed. These are human stories, and while we can’t do much about them, we can take steps to ensure that the same doesn’t happen to us.

A recent article on retirement and estate planning reminds us of the dismal statistic that many people in their 50s have saved amounts for retirement that are clearly inadequate. The personal control and personal responsibility that were touted as major benefits of defined contribution retirement plans have resulted in some people saving more than would have otherwise been possible, but has also resulted in many people saving far less. This method of saving for retirement is in strong contrast to the method that was more prevalent 30 or more years ago, the defined benefit pension plan. In a defined benefit pension plan, a benefit formula established what was to be received at retirement, and the employer had the obligation to provide the necessary funding for that benefit. The risk was on the employer. By contrast, in defined contribution plans, the risk is on the employee. There might be a greater reward for the employee in taking on that risk, but more often there was not. Perhaps our current retirement crisis is the time to give more thought to defined benefit plans.

What is abundantly clear in this economic crisis is the necessity of both younger and older people giving more thought to their retirement savings. Deciding to save more is an easy decision to make, and always the right decision, but it’s difficult to carry out. Once that decision is made, it’s necessary to decide how to invest the savings. My experience with our firm’s retirement plan has led me to conclude that nearly everyone lacks the skill and temperament to invest retirement savings. There are two possible solutions to that problem: for large retirement accounts, an outside adviser can be given authority to invest the account. That’s a decision made based on a high degree of trust, but it gives the average investor a skilled ally in dealing with an uncertain financial landscape. For smaller accounts, a very popular technique is the target retirement method. This is a means of getting expert assistance as well. You decide an approximate retirement date, and that choice results in a mix of mutual funds that is consistent with that intention. And the mix changes as you get closer to retirement, reducing the level of risk.

The process of saving for retirement, for a surviving spouse, or to pass on to children is an important part of the overall wealth planning process. We’ve seen in the past few weeks that some of those plans were based on a failure to understand the risk inherent in them, with disastrous results. As with those people affected by the recent hurricanes, we can feel sympathy, but we must also consider whether our own poor financial planning will put us in the path of a different type of hurricane.

Reprinted by permission of hte Legal Intelligencer.

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Not the one in Galveston; I’m not sure what lesson that teaches other than the need to live somewhere else. I’m referring to the one on Wall Street, which, it’s fair to say, hasn’t ended yet. In many similar situations, employees of the distressed or bankrupt companies had much of their wealth in stock of their employer, either owned outright or through retirement accounts. We have read reports that managements at these companies were urging their employees not to sell their stock, that the company would recover, a classic case of a conflict of interest where retirement accounts were involved. The employees at those companies have suffered and will continue to suffer, perhaps without a solution. Are there lessons for others in this disaster?

As to retirement accounts, these problems suggest a theme often discussed in these blogs: the need to pay attention to retirement accounts and to manage them or obtain skilled management for them. It seems very unlikely that there will be a bailout for the rest of us, so it’s our obligation to find out what to do and do it. This task fall into several categories. I suppose the most difficult is to develop the discipline to save more. Sometimes that means living on less in the present, and that’s always difficult. Perhaps putting a picture of those Lehman employees cleaning out their offices on the refrigerator would help.

Once that decision is made, how are the funds to be invested? My opinion is that nearly everyone lacks the skill to invest for retirement. There are at least two solutions: one is to have a professional adviser. The key is to have a skilled one and to develop a level of trust in that adviser, but never to stop asking questions or trying to understand what’s happening. The second option is to use a target retirement method, by which you choose an approximate retirement date and have an automatic allocation among mutual funds. This allocation changes over time, reducing the riskiness of investments as you get older. Again, the retirement account owner should continue to watch what’s happening and ask questions.

Another element that needs planning is the distribution of retirement assets. In addition to the statutory requirements for minimum distributions, there are questions as to which accounts should be spent first, taxable or tax-deferred, and also which tax-deferred accounts should be spent. Again, it’s important to have advice on this process, because the wrong choice can result in an unnecessary waste of savings.

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The turmoil in the financial markets is certain to result in the loss of many thousands of jobs. The people who hold those jobs undoubtedly enjoy a variety of employee benefits, and some or maybe most of those benefits will be lost along with the jobs. Whatever happens, it’s important to remember that there is substantial regulation of benefits by the Employee Retirement Income Security Act of 1974, known as ERISA, as well as by numerous provisions of the Internal Revenue Code. ERISA and the Code provide rules that must be complied with, and they offer protections for both employees and employers.

ERISA details the rights that employees have to know what their benefits are and what recourse they have if those benefits are lost. ERISA also limits rights, and gives employers the ability to change or eliminate benefits under some circumstances. There are many thousands of lawsuits that have been brought under ERISA, and many of them could have been avoided if one or both parties had simply followed the ERISA rules in claiming or reducing benefits. Here are a couple of examples:

If an employee was covered by health insurance, a law called COBRA contains provisions added to the Internal Revenue Code, permitting a continuation of health coverage for specific periods of time, but at the employee’s expense. If the employer goes out of business and no longer has a health plan, the COBRA rights could be lost.

Many of these employees will have retirement plan accounts. ERISA and the Code describe an employee’s rights to those benefits once employment has ended, and also permit employers to limit those rights to those set forth in the law. If an employee is only partially vested in benefits, the unvested portion may revert to the plan and benefit other employees. It’s important for employers to explain fully the rights that employees have, to avoid accusations by the employees that they were misled.

Employees may have continuation rights in other benefits, such as the right to convert life insurance policies provided by the employer to their personal ownership, or the right to continue disability income coverage.

Employees who have lost or expect to lose their jobs need to examine the documentation of their employee benefits and see what they may retain or continue. Employers need to understand the rights they have to change or eliminate those benefits, as well as their obligations to advise employees of their rights. If both sides know and comply with the law, the process of terminating employment, while still an unfortunate occurrence, will at least be carried out fairly.

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This was the only quote I could think of to introduce a discussion of planning with Roth IRA and retirement plan benefits. In response to this statement, Groucho Marx said: “Is Roth here too? Tell Roth to wax the Dean for a while.”

Delaware Sen. William Roth gave his name to this type of retirement benefit. It’s simple, sort of. You don’t get a tax deduction when the contributions are made, but you don’t pay taxes when the account is distributed at retirement. You give up a current tax saving in exchange for a greater one later. Is this a good deal? The answer is definitely, sometimes.

If you knew that you would pay a higher tax rate in retirement, Roth tax treatment would clearly be better. Conversely, if you knew that your tax rate would be much lower in retirement, it might be better to stay with the traditional method of planning: a deduction up front and taxation later. Opinions vary on this subject, and studies have been made to try to determine when and whether one method is superior to the other. There are some unknown elements: not only your own tax rate but tax rates in general. Who can predict what income tax rates will be 10 or 20 years from now? Or that Roth treatment will still be in effect?

For now, here are two situations in which Roth treatment makes sense. First, if you have a child who has a summer job, it makes sense that the child have a Roth IRA. In most cases, kids with summer jobs have little or no income tax liability anyway, so a deduction for an IRA contribution is of no value to them. Then, they will have many years in which the Roth IRA can grow tax-free. When the funds are distributed, perhaps 50 years later, the small contributions from summer jobs could be a large amount.

Here’s another possible benefit: Roth IRAs do not have minimum distribution rules, unlike standard IRAs and qualified plans. If an individual has other assets such that he or she won’t need the Roth money, the balance can be left in for the rest of the individual’s life and be paid out only in the next generation. This extremely long-term accumulation period, followed by no tax on distribution, can make Roth a valuable planning benefit.

People with standard benefits can convert them to Roth benefits by paying taxes on them now. After that, any distributions will be free of tax. The ability to convert is limited to those with income below certain levels, but that restriction will end by 2010. At that time, anyone will be able to convert to Roth treatment. This opens up the possibility of interesting estate planning with Roth benefits, which we’ll discuss in another blog.

Republished with permission of The Legal Intelligencer.

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The San Diego Union-Tribune has been reporting for some time on the ongoing woes plaguing that city’s retirement system. A story reported on June 14, 2008 indicates that the city had hired a large law firm to look into the problems and to represent it in an investigation by the Securities and Exchange Commission. But, as it turned out, that created a conflict of interest- how could the law firm investigate the problem and at the same time defend the city in the SEC matter? Apparently, it could not, and the city sued the law firm for a very large sum of money. The case was just settled, with the law firm agreeing to return $3.25 million in fees and to forgive outstanding bills of another $1.1 million. This illustrates a couple of points: first, pension plans are important and complicated, and it’s not difficult to cause problems if you’re not sure of what you’re doing. Second, if you are a public entity and you hire someone to straighten out a problem with your pension system, that’s what they should do, not try to minimize or gloss over the problem. Even in private businesses, it makes sense to have someone, such as a law firm that knows what it’s doing, review the administration of retirement plans from time to time, to avoid lawsuits and government investigations.

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Part of planning for the future is deciding where to spend the golden years, as marketing types like to call them. For those people who have an option where to live in retirement, there are the usual suspects: Florida, Arizona, North Carolina and there is the state that is one of the most popular among retirees, Pennsylvania.

By the way, the idea that you need to remain in the city where your law practice is located in order to continue to have an involvement in that practice is fast fading away. Just last week, a lawyer from a suburb of Detroit, who is suing one of my clients, called me from somewhere deep in the heart of North Carolina, from where he is able to be heavily involved in the frivolous litigation he is pursuing.

Why is Pennsylvania so popular among retirees, especially those in the neighboring states of New York, New Jersey, Delaware and Maryland? One important reason is the taxation of retirement income, such as Social Security and retirement plan distributions. There is no income tax imposed by Pennsylvania on bona fide retirement income, which is not the case in the neighboring states. If your income in retirement consists only of Social Security benefits and amounts you withdraw from a 401(k) plan, for example, your Pa. income tax will be zero. That is not the case, again for example, in New Jersey. And if you worked in New Jersey to earn a retirement benefit, New Jersey can’t reach across the river to tax it if you move to Pennsylvania, under federal law. (But here’s a caveat: Be sure to check the Pennsylvania rules to be certain that your retirement distributions qualify. Nearly all distributions after age 59 1/2 will qualify, but check the rules anyway.)

Yes, we have a sales tax, which Delaware does not have (although there are a large number of “big box” stores suspiciously close to the Pennsylvania border) and yes, we still have the state store system (again, some really good wine stores just across the border in New Jersey and Delaware, I’m told), but Pennsylvania has a big advantage in the taxation of retirement income. That, combined with reasonable property taxes and access to a world of sports, culture and recreational activities, is why Pennsylvania has one of the largest populations of retirees of any state.

Republished with permission of The Legal Intelligencer.

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A new book by Alice H. Munnell and Steven Sass, titled “Working Longer: The Solution to the Retirement Income Challenge”, published by the Brookings Institution Press, makes some important points about planning for retirement. Americans, they say, need to work longer because of a contracting retirement income system, the longer lifespans now enjoyed by many of us, and the rising cost of healthcare.

The aim, they suggest, should be to move the average retirement age from 63 to 66. This will increase Social Security benefits payable, permit workers to build up larger retirement balances and reduce the period during which they must rely on retirement assets. One way of encouraging this trend might be to increase the earliest age for receiving Social Security benefits, which is now age 62.

But here’s another one, which I have suggested in earlier posts: provide income tax incentives for workers to continue working beyond age 62. For instance, for those age 62 and over, the federal income tax rate on the first $50,000 of income could be set at 10%, with a 15% rate on the next $50,000. This would surely encourage people to continue working, adding more to Social Security trust funds and delaying the payout of benefits.

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Section 409A of the Internal Revenue Code was enacted in reaction to concerns about the taxation of deferred compensation, especially some of the abuses uncovered in the failure in recent years of several large corporations, including Enron. The law was enacted in 2004, but several extensions were granted of the time to amend plans and arrangements to comply with the new law. Those extensions will come to an end on December 31, 2008. This year it is still possible to make certain types of changes in deferred compensation plans and arrangements without adverse tax consequences, but there will be significant penalties assessed if compliance has not been achieved next year.

This is a good time to review what deferred compensation plans and arrangements are now in effect, whether they need to be amended and how they will be amended. Deferred compensation can be a valuable tool for businesses to provide incentives to executives, but it’s important that the new law be satisfied.

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I know it was discussed extensively over the past few years, but is it no longer front-page news because the problem has been fixed? Apparently not. It’s more likely that the nation is suffering from attention deficit disorder and can only think about high gas prices right now.

But this problem isn’t going away, nor is the Medicare problem on the verge of resolution. Both of these programs face long-term funding challenges and waiting another few years to think about them again isn’t going to make their solution any easier.

An interesting Web site is maintained by the Center for Retirement Research at Boston College, and included on the Web site is a publication called the “Social Security Fix-It Book.” There are only a certain number of possible solutions to these problems, and the center has summarized them in 52 clearly written and entertaining pages. The publication begins with basic facts about how Social Security works and then makes the following fairly simple statement: The only two ways to fix the problem are to cut benefits or increase revenues. There is no magic formula that will painlessly make Social Security financially solvent for the indefinite future.

There are a couple of ways to cut benefits:

• An across the board percentage benefits cut that affects everyone, including those now receiving benefits.
• Raising the normal retirement age for full benefits, as has already occurred.
• Freezing the purchasing power of benefits, which means that future benefit amounts would be lower than under the current law.
• Freezing the purchasing power, but to a lesser degree for lower income earners.
• Changing the cost of living adjustment for benefits.
• Doing nothing and cutting benefits all at once in 2040

And, there are a couple of ways to increase revenues:

• Increasing the payroll tax rate today.
• Raising the cap on earnings subject to Social Security taxes.
• Financing Social Security with revenues from the federal estate tax.
• Transferring Social Security’s startup costs (from benefits paid in the early years of the program) to general revenues.
• Increasing the rate of return on assets held in the Social Security Trust Fund.
• Waiting until 2040 to raise taxes.

What to do? The publication ends by asking these three questions, the answers to which will determine how to fix Social Security:

• Do we want to keep benefits about where they are now? If so, how should the burden be shared?
• Do we want to keep taxes about where they are now? If so, how do we cut benefits?
• Finally, should each generation pay about the same tax and get about the same benefits?

Republished with permission of The Legal Intelligencer.

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This is what a father wrote in a will that was brought to me. It illustrates another fundamental point about estate and retirement planning.

The father had decided to make his estate planning easy. “I’ll just buy CDs in my name and in the names of each of my children. That way, when I die, each of them will have a CD now in his or her sole name.” So, to carry out this idea, the father bought one CD with Child No. 1’s name on it in addition to his, a second in the name of Child No. 2 and the father all the way up to five children. The trouble was, he forgot how much he had purchased for each child, so the amounts were uneven. One child would get $100,000, another $10,000.

But Dad planned how to solve that problem. In his will, he wrote: “If any of the CDs I bought aren’t equal among my children, I ask them to straighten it out.” What do you think happened? Wrong, they did straighten it out. In one of those unusual family situations, the children who got more recognized their obligation to the others and entered into a family settlement. Sometimes it snows in April.

It’s important to remember that a will isn’t the only document that determines how assets are distributed. Life insurance beneficiary forms, retirement plan beneficiary designations and joint title on assets are all forms of testamentary dispositions; that is, they are all wills. Most people don’t know where these forms of wills are, sometimes can’t remember what they say and usually haven’t put them together so that they understand what their estate plan is. But it’s important to do this, because not every family (and, in fact, very few) is as close and understanding as the one described above.

Republished with permission of The Legal Intelligencer.

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