The Pension Protection Act of 2006 (PPA) is long and hard to read, but it played a crucial role in establishing cash balance plans as a viable and legally recognized retirement savings option. Before 2006, cash balance plans faced frequent legal challenges. Those bringing the suits argued that cash balance plans violated established rules for benefit accrual and discriminated against older workers. The rulings on these cases were inconsistent, and many business owners were reluctant to risk establishing a plan that just didn’t have firm legal footing.
The Pension Protection Act ended this uncertainty about the legality of cash balance plans. The legislation set specific requirements for cash balance plans, including:
- A vesting requirement: Any employee who has worked for their company for at least three years must be 100% vested in their accrued benefits from employer contributions.
- A change in the calculation of lump sum payments: Participants in a cash balance plan can usually choose to receive a lump sum upon retirement or upon the termination of employment instead of receiving their money as a lifetime annuity. Before 2006, some plans used one interest rate to calculate out the anticipated account balance upon retirement, but, when participants opted to receive an earlier lump sum, the plan called for using a different interest rate to discount the anticipated retirement balance back to the date of the lump sum payment. This could lead to discrepancies between the hypothetical balance of the account (as determined by employer contributions and accumulated interest credits) and the actual lump sum payout, an effect known as “whipsaw”. The PPA eliminated the whipsaw effect by allowing the lump sum payout to simply equal the hypothetical account balance.
- Clarification on age discrimination claims: A cash balance plan does not violate age discrimination legislation if the account balance of an older employee is compared with that of a similarly situated younger employee (i.e. with the same length of employment, pay, job title, date of hire, and work history), and the older employee’s balance is equal to or greater than the younger employee’s.
There are, of course, many other points included in this lengthy piece of legislation, but the takeaway is this: the Pension Protection Act of 2006 removed the legal uncertainty surrounding cash balance plans and made them a much more appealing option for small business owners. The number of cash balance plans in America more than tripled after the implementation of the PPA. Additional regulations in 2010 and 2014 made these hybrid plans an even better option, and we anticipate that their popularity will continue to grow. There are thousands of high-earning business owners out there who can reap huge, tax-crushing benefits from implementing cash balance plan – they just have to know about them first.
Bloomberg Barclays US Aggregate has a duration of over 6 (orange line) and a yield of just 2.5% (white line). If we see more corporate refinancing on the longer end (while rates are still low) and at some point a 50 or 100 year US treasury makes its way into the index (https://lnkd.in/gFvUF5g), this could be very problematic.
Add to that a higher duration of Agency MBS if rates increase and prepayments slow (extension risk).
This all looks like a huge amount of interest rate risk for investors with very little upside. The solution: talk to your Portfolio Manager.
Saving and Investing for Retirement
As you age, saving and investing for retirement should take on increasing significance and should rank higher on your list of priorities. This is especially true if you lost out on the opportunity to maximize your retirement savings by starting to save from your early twenties or thirties. Nevertheless, with self-discipline and a fool proof plan of action, you can still manage to set aside a nice nest egg for your retirement if you act immediately.
Swift action is particularly important for the self-employed and other professionals. This is because these individuals may not automatically fall under the umbrella of a structured retirement savings and investment plan such as a 401(k). The implications are that deliberate efforts must be made to save and invest for retirement purposes and the onus is on the individual to create and execute a viable retirement plan. However, you should not allow yourself to be forced into investing in a plan that offers high levels of returns without ascertaining for yourself what the risks are.
There are several individual retirement account (IRA) options that are available for the self-employed. The key is to choose one that will work based on your particular retirement goals, risk tolerance and timeline. It may be a good idea to discuss your retirement goals with an experienced Certified Financial Planner or advisor. The closer you get to retirement, the less of your investment dollars you should allocate to riskier investment vehicles such as stocks. Once you hit 45 years, your retirement portfolio should ideally be concentrated on fixed income instruments such as treasury bills and government bonds. The trade-off is that the income is essentially guaranteed but the returns are likely to be lower. It is better to have a smaller return on your capital than to lose your retirement capital.
If you’re nearing retirement, it may be time to consider whether you should take social security benefits early, on time, or late. To make such a decision, it’s important to know how Social Security works. Full benefits are available as early as age 65, depending on your date of birth. You may receive benefits at age 62, but your benefits will be reduced. Or you can delay benefits until age 70, in which case your benefits will increase.
When choosing which option is best for you, there are many factors to consider. Two major factors are your life expectancy and whether you actually need the benefit to support your living expenses.
To understand why, remember that Social Security calculates monthly payments so that if you start early, the smaller payments received over a longer time could total the same amount as if you had started receiving benefits at normal retirement age.
On the other hand, if you start late, the bigger payments received over a shorter time could total the same amount as if you had started receiving benefits at normal retirement age.
However, all these calculations are based on your normal life expectancy. If you live beyond that life expectancy, then delaying benefits will result in higher monthly payments and a potentially higher lifetime total. If you don’t expect to reach or exceed your life expectancy, then it may make sense to start as soon as allowed.
There are many other factors to consider in deciding when to take Social Security benefits. Before you make a decision, it’s wise to seek advice from a professional. Social Security offices across the country have staff available to talk to free of charge. Call the Social Security Administration at (800) 772-1213 for the location of an office near you.
Give our office a call to review your options and evaluate how Social Security fits into your retirement plan.
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