Thread: Deferred Compensation?
05-08-2001, 01:43 PM #1NozzleHogFirehouse.com Guest
I'm wondering how many others are in Deferred Compensation, and if anyone shares my concerns about their own plans.
For those who may not know, a 457, or deferred compensation plan, is the City’s voluntary retirement savings plan (similar to a 401K plan in the private sector. Employees are able to contribute up to a pre-determined amount through payroll deduction and choose their investments (usually mutual funds)to build funding for retirement. The supposed advantages are:
1. they do not pay taxes on this money upon deduction
2. their paycheck is taxed only on the amount after this deduction, and
3. they are then taxed on the funds when they retire and are more likely to be in a lower tax bracket.
Many of us have been taking some hard hits on our accounts, effectively losing money, at least for the short term. There have also been newspaper articles recently that question the long term wisdom of such a plan. The gist of the articles was that it is really just "phantom wealth" or money that exists only on paper since everything is predicated on being able to sell the shares somewhere down the road.
Any financial adviser's out there? Fireman Smith perhaps?
05-08-2001, 03:24 PM #2Nate MarshallFirehouse.com Guest
It's actually a very good plan longterm. If your in it for short term gains there arent any but over 20-25 30 years you will make some serious money.
If you retire early some departments offer DROP which means that if you hit say 18 years and you are going to retire at 20 you can take your money and roll it into an ira and it ends up better for you tax wise.
Lump sums are usually 400-550k or more depending on length of service and rank.
The 457 plan is good but you should balance the aggressive plans with conservative ones if you get to choose. You also should evaluate what your own financial goals are.
Younger people can afford to be aggressive older people close to retirement cannot.
05-08-2001, 11:48 PM #3NozzleHogFirehouse.com Guest
Your opinion on deferred comp. in general is noted but does not really contribute anything new or germane to the question posed. Anyone who has signed up for this type of plan has heard the generalities you mention in your post.
For anyone interested in contributing an informed opinion on this topic:
Washington Post Article
Retire On Phantom Wealth? No Way
By Thornton Parker
Sunday, May 6, 2001; Page B01
The panel named by President Bush last week to study Social Security is almost certain to recommend that workers be allowed to divert some of their Social Security contributions into stocks and private investment accounts. But there is a profound problem with that approach: the fundamental mismatch between what stocks do and what retirees need.
These days, few stocks pay significant dividends, so the only reason to buy them for retirement plans is appreciation -- that is, the expected increase in the price of shares. But until a stock is sold, any increase in its price is just a paper gain, and paper gains don't buy groceries. What retirees need is dependable cash income -- such as dividends once provided.
Baby boomers' retirement plans have created a national stocks-for-retirement cycle, in which workers buy shares that they will sell later for retirement income. Already, about half the value of all U.S. stocks is held in some kind of retirement portfolio -- pension plans, 401(k)s, IRAs and so on. Diverting some Social Security payroll taxes into stocks would increase that proportion. Because this concentration of stocks in retirement savings is unprecedented, nobody has any idea how it is going to play out. Yet, from Wall Street to Capitol Hill, nearly everybody who is talking about stocks and retirement investments is concentrating on the front -- or buying -- half of the cycle and ignoring the back -- or selling -- half.
And it's the selling that becomes problematic, because when stocks currently being held as retirement investments are sold, who will buy them? And as the market becomes flooded with such shares, at what price? Most stocks are purchased by people in their peak earning years, between the ages of 40 and 60. By 2030, about a third of American adults will be in that age group. Another third, roughly, will be at retirement age, from the early sixties on up. They will be selling their stock. The youngest third will be 20 to 40 years old, workers who traditionally don't buy much stock.
The problem with the current Social Security system is this: As the oldest third retires and begins to collect a monthly payment, there will be too few workers among the younger two-thirds to pay the payroll taxes to support it. Stock-based retirement plans have an even greater problem: They will depend for support on just that middle third, the traditional stock buyers, or roughly half as many supporters as Social Security will have.
As with any business that buys things to sell later, two factors will determine whether the stock-based retirement plans can be successful. They are the quantity of stocks that will be sold and the purchasing power that will be available to buy them. Nothing else will matter.
...It seems bizarre that the apparent danger to stock-based plans isn't being discussed. In 10 years, as waves of boomers start collecting their pensions, giant retirement plans such as those at General Motors and IBM, and large state plans such as those of California and New York, will have to begin selling increasing amounts of their stock holdings to pay those retirees. Meanwhile, retirees who look with satisfaction to the substantial paper gains that have accrued to their 401(k)s and IRAs will start selling shares to survive. With the owners of about half of the country's stock shifting from a buying into a slow selling mode, it won't be just a question of stocks not gaining value. The big worry will be: How much can they lose?
According to a recent Barron's article, by the beginning of April, an estimated $5 trillion that was based on stock prices had vanished in the preceding 12 months. That money was phantom wealth.
Phantom wealth is created or destroyed in two steps. The first step is a trade that sets the most recent price for a stock. The second step is the practice of treating all shares of that stock as being worth the most recent price. To understand this, assume that a company has 100 million shares of stock outstanding, and a day's trading leaves the price one dollar higher. When all 100 million shares, including those in retirement accounts, are treated as being worth the new price, $100 million appears to have been created, but nobody knows where all that money came from. If the share price goes down one dollar a day or two later, the $100 million vanishes -- it was only a phantom.
Few people have any conception of how rapidly phantom wealth can disappear as the result of a few trades at lower prices, but it is the primary asset in most pension plans and retirement accounts. There is a serious risk that the planned selling to pay for boomers' retirement consumption can depress stock prices for years, destroy trillions of dollars of phantom wealth.
The president's panel will probably be guided by popular wisdom such as, "Everybody knows that stock prices fluctuate, but over the years, stocks have been very good investments." Much of that universal knowledge comes from widely quoted reports that show how the total returns from stocks have done well for the past 75 years.
But a close look at the data behind those reports shows something much more important. For more than half a century, stocks returned more as dividends than as appreciation. Then, after 1981, retirement savings began to pour into the market and companies were driven to inflate their stocks instead of paying dividends. As a result, returns from appreciation were five times greater than from dividends. Many boomers believe that the bull market that began in 1982 was typical, but the gains of the past 19 years are unprecedented, because they have been driven largely by boomers' retirement plan purchases in the front half of the stocks-for-retirement cycle. If anything, those reports are a warning of what to expect in the back half.
...But someone who builds a nest egg of shares that will have to be sold must decide how long to stretch the sales. I call that the Impossible Decision, because it requires predicting how long one expects to live.
...Overestimating can lead to a lower standard of living than is necessary, while underestimating can lead to spending one's last years in poverty.
Having helped several older friends and family members manage their affairs, I know that security is often their primary concern. I also know that it is harder for many people to make smart, balanced decisions that involve many details at 80 than it was at 40. It is absurd to expect millions of older people to manage the sales of their stocks as market prices keep changing. Individually managed accounts will put additional pressure on them when they retire and can turn their later years into a nightmare.
Many older boomers will find that they should put their assets into pools, like annuities, that can be managed by experts who will make the decisions that they simply can't make for themselves. If those who have only modest savings (and are lucky) do this, they will wind up with something very much like Social Security.
Social Security's problems are well understood because each year it publishes long-term projections. There has never been a comparable projection for the stocks-for-retirement cycle. If Bush's panel is going to make a convincing case for using stocks to supplement Social Security, it must show, in an analysis that is comparable to the Social Security projections, how the cycle can work and who will buy all the stocks that must be sold at prices necessary to support aging baby boomers. The panel must also explain how boomers will handle the Impossible Decision.
The country must avoid rushing into even partial Social Security privatization without thinking it through. We did that with utility deregulation. What we don't need is a retirement brownout.
[This message has been edited by NozzleHog (edited 05-09-2001).]
05-09-2001, 11:36 AM #4Dalmatian90Firehouse.com Guest
Was that article about "Phantom Wealth" or "Phantom Losses" ? After all, a paper loss or paper gain is just that -- on paper until you act on it and make it a real loss or gain.
The article failed to mention other, more stable albeight less quickly growing investments. These include Bonds (which you can put 401k money into, and I assume 457 funds), and investments such as Mortgage-based securities (where companies like Sallie MAE and Fannie MAE pool thousands of mortgages together into a single financial investment)
Speaking of bonds, one of the fundemental financial questions that lurks, if indeed we see the federal surplus projections hold, is what will happen when there are trillions of dollars to invest and no federal treasury bonds left to buy? That money will move into private stock and bond markets, and into municipal bond markets.
There have been real losses last year and this year. And the quick fall of tech stocks fed on itself -- say someone owned 2000 shares at $100 each and sold 1000 shares to buy a house ($100,000). They kept the remaining 1000 shares, and saw the price collapse from $100 to $10. At this point, it's still a "paper loss."
However, it's now April and the tax money comes calling. "You owe us $30,000 on the $100,000 of stock you sold last year in capital gains." (I'm using example figures, I don't know what the cap gain tax would've been). Well now, the remaining shares are worth only $10,000 right now, so you have to sell them at the loss...plus sell other investments to come up with the other $20,000 you owe. In a way like this, stock market volatility can make itself worse just by being volatile.
Good or bad, "privatizing" retirement plans like this place a lot of responsibility on the individual to learn about the markets and watch over their interests carefully. This includes looking 5 or more years into the future and being willing to bite the bullet and say, "The markets high now. I'm selling the volatile stocks, giving up perhaps more gains but avoiding losses, and moving them into bonds and less volatile stocks."
Part of me wishes there was a hybrid pension system -- still professionally managed with defined benifits, but portable that once in a plan, it can follow you employer to employer whether your in the private sector or public sector. Many people end up tied into jobs they no longer enjoy because they need to earn their pension.
05-09-2001, 01:02 PM #5Nate MarshallFirehouse.com Guest
Actually you can have your plan follow agency to agency. Ive done it three times not counting forest service for my IMT work.
The self funded protion is a risk but not much of one, most plans give you a choice of say 30-40 different funds or bonds and rate from conservative to aggressive. I have an even mix of both.
If you want short term growth you wont see much, for long term retirement savings you will still make out okay.
Problem is the tech industry is over rated but Ive been told by our pension fund adninistrator that this will work itself out in the next year or so.
401/457 is still the best option.
05-10-2001, 08:42 AM #6Jim M.Firehouse.com Guest
Any discussion of retirement plans involves two major assumptions. What we THINK we know today and what we THINK or expect to happen in the future.
Based on what I THINK I know today, a deferred comp plan is a good thing. It lowers my current taxes and it allows for the time value of money to grow my savings faster than they would if they were being taxed.
Based on what I THINK will happen in the future, my tax rate will be lower and my retirement pie will last longer.
That's issue #1 about deferred comp in general. In my opinion, an excellent tool for building future value.
Issue #2 is much more complicated. All of these plans offer different investment alternatives. Fixed interest rates, bond funds, stock funds, etc. Those choices depend on your expectation of what will happen to the economy in the future. There's a statistic somewhere that shows most of us will outlive our money because we're too conservative. Yes, paper losses can and do hurt us from time to time, and can be devastating if you need a 100% cash out when things are at a low point. But, on average, look at the rate of return for stocks over the last 100 years compared to fixed rate alternatives. My money is on (and in) stocks.
05-10-2001, 11:54 AM #7Nate MarshallFirehouse.com Guest
i think its important to have balance, mine has both conservative and aggressive investments. many people who would be considered more knowledgable in thsi area have told me that for long term for younger people it is almost better to invest aggressive with 1-2 conservative funds as well. For older people just starting out but closer to retirement age its better to have more conservative types. This is what Ive been told, I gues I ll have to wait for retirement to find out.
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