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Wednesday, February 27, 2013

Means Testing 401 (Wonkish)


 Stories are beginning to abound on the internet and bloggers about the government wanting to ‘help’ people manage their 401k’s.

Having been formerly more involved in the financial planning business, I still keep an eye on the ramblings of various experts in the industry. Most of them are talking about some common sense moves, considering the prospect of a furthering dip in the economy; essentially keeping money in a variety of safe instruments such as bonds, gold, CD's etc., and minimizing risk exposure. The bulk of them are pretty hesitant about plunging back into growth equities, or housing development, at least for the time being.

That's why I read with interest an article yesterday on Bloomberg, and other articles, about 2 out of 3 three planners recommending headlong plunging into equities- in particular, large and small cap growth instruments. Not that it’s all that far off base (it could be a high risk gamble that might just pay off big), it's just I suspect anything that comes out of the media these days; not to mention it also represents a very thin voice in the majority of cooler heads.

I did a little digging and pretty much came up with nothing on the notion, other than the obvious- right now the bond market is pretty flat due to the pouring in of large amounts of money into it. It's too complicated to get into here, but generally when people buy a lot of bonds, the yield goes down. When people buy stocks, the price goes up, and bond yield prices go up- chiefly because companies have a tough time getting cash and offer higher yields to attract bond buyers. 

Thus, they are making the recommendation, because yields are low right now.

But then I thought about the new financial regulations that went into effect recently- one of which requires 401k trustees to disclose to investors about an option offered at the time of retirement, which is called annuitization. Sometimes, when you retire, annuitizing money is a good option to provide a higher level of income than simple distributions, depending on your particular situation. The new regulations call for 401k companies to provide not only an annuitization option, but also to compare it with a 'government average yield index' (I'm not sure if that's the official term) and providing an annuitization option funded with something called 'R' bonds, or the R bond index.

Thus, when you retire, and pull your money from, let’s say Bank of America, they may say to you , "You can annuitize it and get $1200/mo. for the rest of your life" and then you can compare it to the average R bond index, which might be $1500/mo., to see if you are getting a good deal. It was done under the guise of consumer protections- which the Bloomberg article goes into more detail about.

On the surface that seems pretty innocuous- they don't want people ripped off. Except, nobody in their right mind would annuitize the whole 401k, you typically only partially annuitize and hold some in reserve. A good planner always provides numerous options from their portfolio, and you would choose the plan that provided the highest payout for the lowest risk you were comfortable with. The comparison is really redundant, and unnecessary.

So why is it there? And why would the media, mouthpiece of the government, be suggesting a heavy move away from bonds?

Well, the government needs the bond yield to go up. This way the average index number goes up a lot too, since annuitization schedules are typically tied to bond yields.

So what, right?

Right now, the government is howling that Social Security is in serious trouble. The President’s economic people have determined that unless something is done, and soon, Social Security is going to run into serious deficit problems. People are living longer, and less people are putting money into the system. Among the changes proposed was the raising of the retirement age etc., but also, they wanted to add something called 'means testing' to the payout. The general feeling is that people like Warren Buffet, hardly need the extra 2-3k a month SSN checks they get, thus the government could cut off payouts to wealthy individuals and save a bundle. The only way to determine that is something called 'means testing', where the government calculates your estate at retirement, and then lowers your Social Security if you are making a lot of money from your estate or income sources.

The big problem is that there was (before the new financial regulations) no way to determine the monthly payout value of IRA's, 401k's and other tax deferred plans, because they are typically invested in variable instruments (like stocks and bonds) and the payout will fluctuate accordingly. As a result, 'means testing' hit a brick wall.

Unless, of course, you annuitize.

Thus, by enforcing an index on every tax deferred instrument in the marketplace, you have instantly assessed the retirement income value of every American.  The higher that index is the more money you can deduct from Social Security payouts.

In short, by replacing your Social Security payout amounts with your own money saved, the government just stole potentially trillions of dollars from Americans savings in order to pay its own debts.

Uncle Sam just seized everyone's 401k, at least to some degree.

More importantly, it is communism defined. To take from the wealthy, in order to give to the poor, or worse, the government, is the very tenet of communism. To do this would gut the entire point and value of retirement savings, and the concept of tax deferral. And since the 401k and traditional IRA's are considered taxable income, you would get whacked again at retirement. Money was taken out of your paycheck to pay Social Security, and now the money is reduced as a tax deferred replacement. Even if Social Security is considered taxable income, taxes aren't directly deducted from it- they would be, however, if it were replaced with your 401k money.

Authors Dean Baker and Mark Weisbrot, who are financial gurus on the market and Social Security, put it bluntly:

"It is not just the absolute numbers that are significant but the nature of the program as well.  Social Security is a social insurance program in which retirement benefits are proportional to one’s payments into the system.  Means-testing would convert the system into a welfare program.  And we know from the recent cancelation of the most important federal welfare entitlement, AFDC, how much more difficult it is to defend welfare against political attacks than it is to defend social insurance."- Social Security: The Phony Crisis 

Both sides of government want to do this, mainly because they are not telling the American people that we are broke and the Social Security trust fund represents the largest lump sum of cash lying around today, not only in the United States, but quite possibly worldwide. Such a means testing system, would remove generations of protections built into the system, and allow government to tap consumer’s wallets with virtually unlimited power, without raising the possibility of Americans howling about new taxes. You wouldn't see the freight train on this until it was right on top of you at retirement.

All they would have to do, is recommend you sell bonds (or even buy them up with your tax dollars) to artificially raise the R bond index level. Even a small change to the index, if linked to means testing Social Security, would flood the tax coffers with new revenues.

That's the thing about government and regulation, and why new regulation is almost always a bad idea. 

You just can't trust those guys.