Group defined benefit plan- good idea?

[wp746911]

I'm maxing out my groups 401k. My group has a defined benefit plan (used to be a 412 plan) which is 'mandatory'. It is funded with an annuity (https://www.llic.com/annuities/marquiscentennial), with the expected contribution being around 5k per month for me (in my 30's). I'm still having a tough time getting details from the advisor who set the plan up... The advantage is a lot of pretax savings, the downside is a long long time of very low growth. As a general statement, does something like this sound like a good idea? If it's not, what else should I consider?

[litovskyassetmanagement]

Rex wrote:

Absolutely the worst of all the defined benefit plans in my opinion.

The reason the deductions are so high is because you are paying the most for the same defined benefit.

http://thewpi.org/?a=PG:857

Good luck.

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Great description, not much to add.  Basically, you can't even roll this money into an IRA.  The adviser who sold is definitely having a good day because this is probably funded with whole life insurance for which he's getting quite a lot of commissions.  I see why they did it with a group practice that probably does not have non-doctor employees.

The biggest selling point by the way is the guaranteed return and the fact that many groups experienced huge losses inside their DB plans because their investments were mismanaged.  This also should be addressed.  So a low return isn't necessarily a bad thing.  What is bad is not getting a return tied to the markets.  Return from bonds will always be higher than guaranteed return on life insurance, and over decades, this can be a substantial amount.

[wp746911]

Well there is some tying to the market- the annuity that its in tied somewhat to the S&P (although I can't get ANYONE to tell me exactly how- other than 'trust me'). From my link I posted in the main post:

"A Marquis Centennial Indexed Annuity (LL-11-FPIA-1) is a deferred, indexed annuity offered by The Lafayette Life Insurance Company. It provides safety of principal and has the potential to earn interest based on the positive movement of the S&P 500® Index (S&P 500) ¹ and a fixed account that provides a guaranteed interest rate."

So there is some relationship with the S&P but with a CAP, which severly limits the upside of the plan. I'm pretty sure the advisor (salesman) who sold this to our group doesn't know and is unable to independently tell me the yearly return of this plan or how exactly the returns are calculated (I've asked and he offered to setup a conference call with the company)...

So what are better options? A DBP where our group manages it's own investments?

[litovskyassetmanagement]

The crediting formula is not working in your favor, so your participation in the upside is severely limited, and yes, the salesperson is getting the big commission on this one as well, so these products are aggressively marketed.  And of course, most of the actual math is beyond his pay grade, that's for sure.  Very few of these salespeople understand the details and complexities of these products.  Wouldn't it be nice to get all of the upside of the S&P with no downside?  That is never the case.  You can not have something for nothing - someone has to pay for the risk, so you absolutely have to consider the cost of risk management.

There is an alternative to 'our group manages it's own investments', which you can't do anyway.  How do you propose to manage a single pooled account?  Who will do it?  Imagine the liability if a small number of people make the investment decisions for the rest, placing trades, rebalancing, etc. - this is not a 401k plan.  What you want is an ERISA 3(38) investment adviser who specializes in managing pooled portfolios.  You will need a custom-designed portfolio for your group that takes into account contribution level, years to retirement, plan liabilities, etc., and do all of that for a fixed/flat fee, not an asset-based fee.  So your portfolio might have some stock exposure, and also manage various types of risk (i.e. many participants retiring, which might require a significant sale of assets at the worst possible time if the market falls).  Also you will need to coordinate the investment strategy between the CB plan and your 401k plan, because after all the CB portfolio is an 'average' portfolio for the entire group, which is just fine, as you can adjust your individual 401k plan allocation to compensate for the extra fixed income exposure.

I've developed a model for managing CB portfolios at the request of one such group CB plan which had a manager charging 1% and using an actively managed (and therefore underperforming) portfolio that had a very heavy stock exposure (and they had a number of near-retirees).  The crediting rate should also be selected accordingly so that not to undermine the plan by requiring too much risk exposure.

[Zaphod]

Thats a lot of mandatory money getting thrown away on what sounds like a awful setup. Maybe you can convince them to change it?

[litovskyassetmanagement]

Zaphod wrote:

Thats a lot of mandatory money getting thrown away on what sounds like a awful setup. Maybe you can convince them to change it?

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This can rarely be done in a group practice. Chances are the guy who sold them the plan is an adviser of one or more of the partners.  I've seen this before, and even though I try to help such practices, the chances are near zero that they will change this set-up, unless some of the older guys retire and the younger ones take over the plan management and decision-making.

[wp746911]

Yep I've tried talking to the partners- one is suspicious of the plan. The others are pretty sure this is the best plan ever and are confused that I don't understand how good it is. I'll be partner soon- might have to wait until then to push for change. I might might be able to get them to at least listen to other options, but we'll see.

[Zaphod]

wp746911 wrote:

Yep I’ve tried talking to the partners- one is suspicious of the plan. The others are pretty sure this is the best plan ever and are confused that I don’t understand how good it is. I’ll be partner soon- might have to wait until then to push for change. I might might be able to get them to at least listen to other options, but we’ll see.

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What? This is crazy. And its mandatory? I would first, make a presentation or something and show everyone whats going on and let them have a chance at being civil and democratic about it. Then, when they of course double down (as appears is normal) on their position I would find a way legal or otherwise to get out of it, no way I would drop 5k a month on a plan thats going to leave you worse off and in less control than a taxable. I would freak out like you wouldnt believe.

There were similar craziness's at my friends practice in all kinds of aspects of the business, he had to leave, I was surprised he made it that long.

[wp746911]

So back to this topic- if this plan is bad, are there other better plans to replace this? As I'm understand this a defined benefits plan might not be a bad idea, but it's just not structured right? It should be run outside of an annuity/insurance vehicle?

[litovskyassetmanagement]

wp746911 wrote:

So back to this topic- if this plan is bad, are there other better plans to replace this? As I’m understand this a defined benefits plan might not be a bad idea, but it’s just not structured right? It should be run outside of an annuity/insurance vehicle?

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As with any product, there is first a specific need that has to be addressed, and the product is selected to address it. If you want to have a group DB plan, it has to achieve certain goals, and so a plan should be designed to accommodate the goals of the partners of your practice.  A plan might have a customized contribution structure where you can decide how much to contribute (anywhere from nothing to say $100k a year for example).  Forget insurance.  That stuff is always SOLD.  You won't find a single fiduciary using insurance inside a DB plan. You can hit all of your goals using basic off the shelf parts cost effectively and in a way that would work very well once partners want to retire and take their money with them.  DB plans have been used for that purpose for decades, and it is simply a matter of figuring out how to structure your plan in a way that would work for all partners.

[wp746911]

Confusion with a few things mentioned here:
1) the current plan is a defined benefits plan- it used to be a 412 but is not anymore.
2) the plan is funded with an indexed based annuity - not a life insurance plan per se.

Does this change anything? Seems that most people are against it being funded by life insurance or a 412 - which it's not.

[litovskyassetmanagement]

wp746911 wrote:

Confusion with a few things mentioned here:
1) the current plan is a defined benefits plan- it used to be a 412 but is not anymore.
2) the plan is funded with an indexed based annuity – not a life insurance plan per se.

Does this change anything? Seems that most people are against it being funded by life insurance or a 412 – which it’s not.

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Yes, index-based annuity is even worse.  They also get a huge commission, and the crediting rules are so complex that none of the salespeople know how they really work because it is a complex mathematical formula stacked against you in multiple ways.  Yes, this is an inappropriate product just like it would be outside of the DB plan because you don't get anything close to what the salespeople SAY that you'll get with this product (there is no way on Earth to get S&P participation without the downside for free). A DB plan should be funded using bonds, individual bonds and/or bond funds, and possibly stock index funds (depending on the stock/bond allocation for your plan).

So if this is NOT a 412i and we are simply talking about investments, then you should hire an ERISA 3(38) fiduciary to advise the plan sponsors on how to develop and manage plan investment portfolio.

[wp746911]

Ok thanks- sorry for the confusion. This is a defined benefits plan which uses an indexed based annuity to fund it. The 'guy' who has advised the group to get this annuity 'specializes' in annuities and life insurance plans... The plan also USED to be a 412 plan but he changed the type.

This has all been a big eye opener for me. I was shocked to find out 2 weeks ago that this was 'mandatory' (never mentioned in contract, during group meetings, etc) and have been struggling to make sense of it sense then. Thanks for your help!

[litovskyassetmanagement]

Well, therein lies the problem.  Group DBs are prime target for AUM advisers and various types of salespeople.  Only the lucky few read WCI first before doing harm to their finances (in one way or another).

[litovskyassetmanagement]

wp746911 wrote:

Ok thanks- sorry for the confusion. This is a defined benefits plan which uses an indexed based annuity to fund it. The ‘guy’ who has advised the group to get this annuity ‘specializes’ in annuities and life insurance plans… The plan also USED to be a 412 plan but he changed the type.

This has all been a big eye opener for me. I was shocked to find out 2 weeks ago that this was ‘mandatory’ (never mentioned in contract, during group meetings, etc) and have been struggling to make sense of it sense then. Thanks for your help!

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You absolutely SHOULD NOT have any type of mandatory contribution.  That's designed to make this adviser a lot of money on the product commission of course.  The contribution should be tiered, starting from ZERO all the way up to whatever the maximum amount that makes sense ($75k-$100k or so).  So you should be able to change your amount of contribution once in a while, and not have to contribute a certain amount.  Like I said, fiduciary is the key word here:

http://litovskymanagement.com/2014/01/hiring-fiduciary-adviser/

While this does not address the DB plan specifically, the ideas are the same (and it is even MORE important to get a real fiduciary who will work FOR you not for themselves and their firm, and whose compensation is fixed/flat and depends only on the level of service that they provide).