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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In an effort to understand how the current financial crisis is being addressed, we plan to post on this blog information about what is being done; not speculation or suggestion, but announcements of what steps are being taken. Here is the Treasury Department announcement on actions to stabilize money market funds:

September 19, 2008
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Treasury Announces Guaranty Program for Money Market Funds
Washington- The U.S. Treasury Department today announced the establishment of a temporary guaranty program for the U.S. money market mutual fund industry. For the next year, the U.S. Treasury will insure the holdings of any publicly offered eligible money market mutual fund – both retail and institutional – that pays a fee to participate in the program.

President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund for up to $50 billion to guarantee the payment in the circumstances described below.

Money market funds play an important role as a savings and investment vehicle for many Americans; they are also a fundamental source of financing for our capital markets and financial institutions. Maintaining confidence in the money market fund industry is critical to protecting the integrity and stability of the global financial system.

Concerns about the net asset value of money market funds falling below $1 have exacerbated global financial market turmoil and caused severe liquidity strains in world markets. In turn, these pressures have caused a spike in some short term interest and funding rates, and significantly heightened volatility in exchange markets. Absent the provision of such financing, there is a substantial risk of further heightened global instability.

Maintenance of the standard $1 net asset value for money market mutual funds is important to investors. If the net asset value for a fund falls below $1, this undermines investor confidence. The program provides support to investors in funds that participate in the program and those funds will not “break the buck”.

This action should enhance market confidence and alleviate investors’ concerns about the ability for money market mutual funds to absorb a loss. Investors in money market mutual funds with a net asset value that falls below $1 would be notified that their fund triggered the insurance program.

The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934. This Act authorizes the Secretary of the Treasury, with the approval of the President, “to deal in gold, foreign exchange, and other instruments of credit and securities” consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. More information on the Exchange Stabilization Fund can be found at http://www.treas.gov/offices/international-affairs/esf/.

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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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