Retirement Plans from Hell (Forbes)

Money & Investing
Retirement Plans From Hell
Scott Woolley, 07.13.09, 12:00 AM ET


Early this year the woman overseeing the 401(k) plan for a rural Oregon company gathered her 25 colleagues together to hold an election. At stake: whether to continue paying AIG an annual 1.25% of assets to manage their 401(k) plan as part of an insurance contract, or switch to mutual funds costing a third less. No surprise that the proposal to convert passed easily.

Then the nasty surprises started popping up. As she sought to unwind the plan, the administrator discovered that AIG had been tacking on a variety of fees all along. One nicked employees for 2% annually when they borrowed money from their own 401(k)s--work the new plan was willing to do for a flat $50 a year.

To top it off, AIG said that many of the employees would have to wait five years to get back their entire nest eggs, with no choice but to keep paying the fees. AIG says such lockups are disclosed in its plan contracts and are shorter than the ones many other insurers impose.

The company's frustrated administrator, who agreed to talk only anonymously, says she's still baffled by the complex annuity contract. "We still don't have a good handle on what they're charging us," she says.

Like the Oregon outfit, lots of mostly small companies are finding out the hard way that the 401(k) plans they bought from insurance companies, usually set up as "group annuities," came with a variety of hard-to-find charges and lockups. Or, more aptly, the plans they were sold by people motivated by lavish commissions. Many hyped the product as a low- or no-cost proposition for employers while glossing over the fees charged to employees. A successful ruse it is. All told, insurers have lured 18,000 companies into parking $185 billion of 401(k) assets inside group annuities and similar insurance contracts, according to an analysis by Larkspur Data Resources of plans with under $250 million in assets.

"Insurance companies cater to the smaller, less sophisticated part of the market," says Robert Prall, managing partner of Rx Investment Solutions, which advises companies on how to build low-cost 401(k) plans. "Every time we've gone into a company that has a group variable annuity contract, no one has really understood how it worked."

One John Hancock group annuity contract allows it to skim off up to 5% of assets before the remains go to work for savers. That's on top of "trailer" commissions of up to 1.4% of assets annually for as long as the plan exists and "asset charges" of up to 4%. John Hancock says those maximum fees provide a distorted picture and that it offers a variety of competitive rates. Why then, you might ask, does another piece of fine print state that John Hancock makes no claim "that any expenses paid directly or indirectly by the plan are reasonable"?

"When it comes to fee abuse in retirement plans, you can put group annuities at the top of the list," says Daniel Maul, an investment advisor in Seattle, Wash. who helps small firms set up 401(k) programs.

Among 401(k) plans with assets of less than $250 million, group annuity-style menus account for 55% of the market and are sold by AXA Equitable, Lincoln Financial and other insurers. A few are like the deferred annuities sold outside retirement plans that combine some life insurance coverage with savings features. Those products typically offer investors a choice of mutual funds; the insurance takes the form of a pledge to pay their heirs what they put in if they meet with an untimely end at a point when the value of their assets has fallen. At the end of their careers, deferred annuity holders can receive their savings either as a lump sum or as annuity payments for life.

By contrast, the group annuities containing 401(k) plans often provide neither a meaningful insurance benefit nor an annuitization option. In fact, beyond the same features that plain vanilla mutual funds offer for a fraction of the cost, group annuities' only upside is a tax benefit--for the insurers selling them, not for the 401(k) investors.

It works this way: Inside group annuities, legal title to the mutual funds belongs to the insurers. This ownership bestows on them the right to claim a corporate dividend received credit, an old feature of the tax code aimed at preventing the double-taxation of profits at the corporate level. Investors don't get a special tax benefit. The fact that annuities may be tax-deferred is irrelevant inside a retirement account, which is tax-deferred no matter how it is invested.

The annuity trappings do, however, mean that investors get hit up for higher fees. John Hancock's group annuity offers the JH American Funds Growth Fund of America at a cost of 0.91% annually. Other 401(k) investors can get an identical fund at less than half the cost.

An accountant at a five-person Texas firm was shocked to discover while looking through his 401(k) statements recently that AXA Equitable's group annuity was charging 1.69% annually to own its version of an S&P 500 index fund. The 0.64% charged for the fund alone is four to five times what low-cost providers Fidelity and Vanguard charge.

The fact that group annuities are sold at all is largely a function of muddled 401(k) regulation. By styling 401(k) plans as group annuities, sellers can shop for the most lax oversight. That's because regulators let insurers decide for themselves whether these products are securities, in which case they are overseen by the Securities & Exchange Commission and must be sold with a prospectus disclosing costs and other details. Or insurers can declare their group annuities are purely insurance products. Insurance regulators tend to focus on an issuer's claims-paying ability rather than its disclosure; most states allow insurers to sell group annuities without even issuing a prospectus.

While insurance salesmen are free to present themselves as honest brokers, they are not required to regard themselves as fiduciaries with a legal obligation to put plan participants' interests first. Often they don't.

Among 401(k) plans designed for small companies, the total fees on some group annuities can top $1,000 per participant every year, or three times what low-cost 401(k) plans cost, according to data provider 401kSource. Have second thoughts after signing up and you'll discover that buying a group annuity is like joining the Sopranos.

"Surrender charges allow insurers to offer very generous commissions," explains Parker Payson of Employee Fiduciary, a Mobile, Ala. firm that sets up low-cost mutual-fund-based 401(k) plans for small companies. "The annuity provider wants to make sure the client is there long enough to recoup the commission."

Some insurers, including New York Life, refuse to offer group annuities. Deanna Garen, a managing director for the firm, points out that, in theory, retirement savings plans with annuitization features are a great idea. Unfortunately, says Garen, the ones on the market are too confusing and costly.

"They just haven't evolved to the point where there are sensible fee structures," she says.

Customers, for the most part, haven't evolved to the point where they know what's going on. Two-thirds of workers are unaware that they're paying anything for 401(k) plans, according to a 2007 survey by AARP. Another 20% aren't sure. Even among the handful who understood that fees are deducted from their accounts, few could say precisely how much they're paying.

Advice to employees: You don't have to take any of this lying down. Find out what you're paying to have your money managed. If it's too much, complain to the benefits department.

Last Minute Tax Tips (Fidelity)

Tax tips and opportunities for 2011 returns
Fidelity Viewpoints — 03/14/12
What to watch for and take advantage of before April 17.

Tax season is once again upon us, and knowing what you can and can’t deduct is probably top of mind for most Americans. On a positive note, Congress avoided a year-end flurry of tax-law changes in 2011, which may make filing returns this year somewhat less complicated. Still, taxpayers can expect a few challenges—as well as some opportunities—as the April 17 filing deadline approaches.

New forms and procedures are causing some confusion over the reporting of capital gains and self-employment deductions, while tax deferrals taken in previous years by some homebuyers and Roth IRA (individual retirement account) owners are now coming due.

However, many of the limits on tax-saving provisions have increased, and taxpayers might be able to capitalize on a number of deductions that are often overlooked. Plus, many investors may be able to contribute to an IRA and reduce their 2011 taxable income right up to the filing deadline, which has been extended by two days because of a holiday observed by the District of Columbia.

To help you sort through the clutter as you delve into your 2011 tax return, here’s a list of items that are likely to affect a wide array of taxpayers this season.

Last-minute moves to consider
Contributing to a qualified retirement plan remains one of the most effective ways to lower current-year income tax for many taxpayers. It’s too late to contribute 2011 dollars to a 401(k) plan or similar workplace savings plan, but other options are available until April 17, including:

Individual retirement accounts (IRAs).
For Roth IRAs, taxpayers who qualify can contribute up to $5,000 for 2011 if their modified adjusted gross income is below $107,000 (single) or $169,000 (married filing jointly). If you’re age 50 or older, you can contribute up to $6,000 for the year.

Keep in mind that contributions to a Roth IRA are not tax deductible. A Roth IRA’s primary advantage is that all qualifying retirement withdrawals are tax free.

Simplified employee pension plan (SEP-IRA).
A SEP-IRA is for self-employed people and small business owners. Contributions are made by the employer only and are generally tax deductible as a business expense. If you’re self-employed, you can contribute up to 20% of your 2011 income ($49,000 maximum) to a SEP-IRA.

Health savings account (HSA).
The 2011 limits for tax-deductible contributions to an HSA are $3,050 for individuals and $6,150 for families ($1,000 higher in each category for people age 55 and older). HSAs require participants to have high-deductible health insurance, and contributions must be used for qualified medical expenses.

Changes to make note of
A couple of reporting procedures and several increases in deductibility and eligibility limits are getting most of the attention this year. They include:

Cost-basis reporting.
If you invest in stocks or mutual funds, you’ve probably heard about the new IRS rules for reporting the cost basis on shares you sell. Cost basis is what you paid for your shares, including any required adjustments. It’s used to calculate your profit (or loss) when you sell. There are several methods for determining cost basis, and you can decide which one makes sense for you.

For tax purposes, it’s your responsibility to report to the IRS your capital gains or losses when you sell securities or mutual fund shares. The IRS has updated Schedule D and incorporated a new form (Form 8949) which requires you to list specific transactions in detail. To make it easier for the IRS to check the accuracy of your reporting, the agency is phasing in a requirement that financial services companies have to report cost-basis information directly to the IRS.

For 2011, the only cost-basis information reported to the IRS will be for the sale of stocks acquired in 2011. Cost basis for your mutual fund shares won't be reported to the IRS in 2011, but you’ll still have to report the cost basis for those shares on your tax return, and specify that those shares are "noncovered."


Self employment tax.
For 2011 only, self-employed taxpayers get a break on their Social Security tax. Instead of paying a rate of 12.4%, the Social Security component of their self-employment tax is 10.4% on the first $106,800 of income. The Medicare tax component stays at 2.9%. If you qualify for this tax break, you’ll have to follow a slightly different procedure for arriving at your self-employment tax deduction on the first page of your tax return.

Deduction and exemption increases.
The perennially troublesome alternative minimum tax(AMT) has gotten its perennial patch. The 2011 exemption increases to $48,450 for single filers, $74,450 for joint filers, and $37,225 for married taxpayers filing separately.

If you choose not to itemize your deductions, you can claim the standard deduction. The 2011 amounts for most taxpayers increased to $5,800 (up $100 from 2010) for single tax filers, to $11,600 for married filing jointly (up $200 from 2010), and to $8,500 for head of household (up $100 from 2010).

The 2011 mileage rate for business use of your car is 51 cents a mile before July 1, 2011, and 55½ cents after June 30. That compares to 50 cents in 2010. The rates for miles driven for moving and medical purposes also increased.

Important reminders
Sensitive to the weak economy, Congress gave taxpayers two opportunities in recent years to defer a potentially significant portion of their tax bill. The downside of those opportunities has now arrived.

2010 Roth IRA conversions.
Taxpayers who converted assets in a traditional IRA to a Roth IRA in 2010 had the option of a one-year deferral of the tax due on the conversion. If you took advantage of the opportunity, you must now, with your 2011 taxes, pay half of the tax owed on the conversion, and the remaining half in 2012.

First-time homebuyer credit.
Congress helped first-time homebuyers with a tax credit of up to $7,500 in 2008. The catch was that the credit was essentially a 15-year interest-free loan. The first of the 15 repayments was due with 2010 tax bills, and the second is due this year. If you’re having trouble raising the cash for the payment, consider increasing your paycheck withholding this year to avoid a similar crunch next year.

Don’t miss these often overlooked deductions
Sales tax option.
For several years, taxpayers who itemize deductions have been able to choose between deducting their state income tax payments or their state and local sales tax payments. In states without an income tax, the choice is easy. In most other states, the math has usually worked out in favor of deducting the income tax.

But many taxpayers overlook the impact of large purchases, such as a car, boat, or RV. To save you the hassle of collecting your receipts for thousands of small purchases, the IRS allows you to deduct a sales tax estimate based on your income and where you live. The tax on a vehicle purchase (and, in some cases, a major home improvement) is counted in addition to the estimated amount, which can tip the calculation in favor of the sales tax deduction.

Energy-efficiency credits.
These have been around for a few years, but they can still be effective at saving tax dollars. In general, making energy-saving improvements to your home by installing energy-efficient windows, doors, roof, heating system, and other items may allow you to claim a tax credit equal to 10% of the cost, up to $500 (lifetime), depending on the type of improvement made. The credit is even higher if you install an alternative energy system. Learn more about available credits on the government’s Energy Star website.

Unreimbursed work expenses.
Many people fail to deduct work-related expenses, perhaps because they can only deduct the amount that exceeds 2% of adjusted gross income. But the eligible items can add up. A few of the potential deductions are depreciation on a computer or mobile phone required for your job, professional society dues, employment-related education, and uniforms. For a complete list, see IRS Publication 529, Miscellaneous Deductions. Plus, there’s a special deduction of up to $250 for teachers who use their own money to buy school supplies.