Data & Research February 20, 2018

By Cutting Back, Current Retirees Navigate Financial Shocks

Some of today’s retirees are financially fragile, but most appear able to absorb financial shocks without incurring severe hardship; this may very well change in a DC plan-dominated future, CRR researchers warn.

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The latest analysis from the Center for Retirement Research (CRR) at Boston College asks the critically important but difficult to answer question, “Will the financial fragility of retirees increase?”

To answer the question researchers first examine the share of expenditures that a typical elderly household devotes to basic needs. Next they review evidence on the ability of today’s elderly to absorb two major shocks—namely, a spike in medical expenses and a decline in income when widowed. Finally, researchers consider the dependence of today’s and tomorrow’s elderly on personal financial assets—particularly 401(k)s and other retirement accounts—mapping anticipated dependence against the sufficiency of assets. 

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At a high level, researchers conclude that “most current retirees can absorb a shock.” However, they warn in no uncertain terms how future retirees are more likely to experience financial fragility, unless they dramatically reduce their fixed expenses or draw increased income from their assets.

The CRR analysis points to a number of studies to show nearly 80% of the spending of a typical elderly household is used to secure five “basic” needs, i.e., housing, health care, food, clothing, and transportation. These needs account for an even greater share of the expenditures of lower-income households, single individuals, and households that rent or have an outstanding mortgage.

“If necessary, households could cut back on entertainment, gifts, and other non-basic items, which include cable TV or a cell phone,” researchers suggest. “Spending on basic needs could also be trimmed. These figures nevertheless suggest that typical retirees cannot cut expenditures by more than about 20% without experiencing hardship.”

The research suggests that while some of today’s retirees are financially fragile, most appear able to absorb shocks without incurring hardship.

“For a small share of retirees both medical expenditure shocks and widowhood create hardship, identified as cutting back on needed food or medication due to a lack of funds over the previous two years,” the CRR finds. “Overall, only 10% of the elderly reported such cutbacks. Interestingly, though, even among households well above the poverty line, 5% reported cutbacks.”

Put simply, the study shows health declines were a clear predictor of hardship; the study also finds evidence that becoming a widow increases hardship. While most of today’s elderly seem able to withstand shocks, changes in the retirement landscape suggest that future retirees will face much more difficulty.

“First, to maintain their standard of living, they will increasingly rely on income drawn from financial assets accumulated over their working careers. This transition in the form of retirement income is largely due to the shift from traditional employer pensions to 401(k)s,” the CRR notes. “Second, not only is the form of income changing, but its overall level—relative to pre-retirement earnings—is declining. Social Security will replace a smaller share of earnings at any given claiming age. And the shift to 401(k)s suggests that many households could also receive somewhat lower replacement rates from employer plans.”

The CRR’s conclusion is that in this changing environment, retirees will face challenges in drawing an income from their nest egg that is “both sufficient and dependable” and, thus, could end up experiencing greater financial fragility.

“With the growing reliance on financial assets, deciding how best to draw down these assets becomes a more critical decision for retirees,” researchers add. “Given that very few purchase annuities, the income that retirees can get largely depends on how they invest, their investment returns, and the pace at which they draw down their savings. The 4% drawdown rule, traditionally considered ‘best practice,’ says that retirees have little chance of running out of money if they invest about half their savings in stocks and at age 65 draw out 4% of their savings, with the amount thereafter rising in line with inflation. Many experts now think that a 4% drawdown rate is too high, given rising longevity and potential declines in investment returns.”

Whatever the safe withdrawal rate and asset allocation, the risk of running out of money rises if retirees draw out more or invest a different amount in equities, the CRR concludes.

Compliance February 20, 2018

Participant Fails to Show Harm in Retirement Plans Acquisition

After the plaintiff’s employment at Siemens concluded, Siemens sold one of its business divisions to Sivantos, Inc., and as part of the sale, Siemens transferred to Sivantos the obligation to pay the plaintiff’s benefits.

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In a case in which Siemens Corporation transferred retirement plan obligations to the acquirer of one of its business divisions, an appellate court found the plaintiff did not allege an injury in some counts and failed to state a claim in one count.

The plaintiff worked for Siemens for 27 years and participated in several retirement plans governed by the Employee Retirement Income Security Act (ERISA): two defined benefit (DB) plans and two defined contribution (DC) plans. After the plaintiff’s employment at Siemens concluded, Siemens sold one of its business divisions to Sivantos, Inc., and as part of the sale, Siemens transferred to Sivantos the obligation to pay the plaintiff’s benefits.

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Counts one through five of the complaint were as follows: (1) breach of fiduciary duty, (2) engaging in a prohibited transaction, (3) declaratory judgment to enforce rights, (4) declaratory judgment to recover benefits, and (5) failure to provide information. Count six was a promissory estoppel claim based on the allegation that Siemens had promised the plaintiff it would be responsible for paying his pension benefits. He alleged that he was injured because he would not have invested in the plans if he had known they would be transferred; the transfer “substantially increased [his] risk of loss;” an insurance policy and a trust meant to protect participants in the event of default were nonexistent or insufficient; some DC investment options were no longer available after the transfer; and some of the new investment options “charged considerably higher management fees” and “generated less return than the investment vehicles [he] had chosen through Siemens.” The plaintiff did not allege that Sivantos had failed to pay him any benefits he was owed.

Siemens filed a motion to dismiss, which a U.S. District Court granted. It ruled that the plaintiff lacked Article III standing to assert all of his claims, and in addition, he had not exhausted administrative remedies for his claims relating to the DC plans. The 3rd U.S. Circuit Court of Appeals affirmed dismissal of the suit, although on some points for different reasons.

The plaintiff first argues that the District Court misapplied the dismissal standard because it disregarded his allegations, did not assume their truth, and considered facts outside the complaint. The appellate court found this not to be true.

DB plan claims

The 3rd Circuit noted that counts one through four pertained to both the DB and DC plans, but the District Court correctly ruled that Krauter lacked standing to assert these claims with regard to the DB plans. According to its opinion, standing requires: (1) “an injury in fact,” which is “an ‘invasion of a legally protected interest’ that is ‘concrete and particularized,’” (2) “a ‘causal connection between the injury and the conduct complained of,’” and (3) “a likelihood ‘that the injury will be redressed by a favorable decision.’” The appellate court agreed with the District Court conclusion that the plaintiff did not allege a concrete injury in fact because Siemens’ actions did not harm him. Instead, the complaint “simply hypothesizes that he would incur harm in the future if Sivantos’ actions lead to missed payments,” an injury the lower court ruled “merely speculative and not concrete.”

According to the appellate court, on appeal, the plaintiff fails to show that these conclusions are erroneous with regard to his DB plan claims, and it said its precedent finds that the risk of future negative effects on benefits is too speculative to confer standing.

The 3rd Circuit found the plaintiff’s pleading of monetary and non-monetary harms consists of a list of his alleged injuries accompanied by his bare assertion that they are injuries in fact. However, the plaintiff cites no authorities supporting his view. “His allegation that he would not have participated in the plans had he known Siemens might transfer them is, as Siemens points out, just another way of expressing fears about a possible future default. His allegation that Siemens breached its fiduciary duty by acting ‘in furtherance of its own . . . interests, and against [his] interests,’ lacks factual specificity and is conclusory. His allegations about discontinuance of insurance and failure to fund a rabbi trust (both of which would pay benefits upon a default) are too speculative: Krauter would only be harmed by their absence if there were to be a default. Krauter’s third argument is that increased risk of future harm confers standing. Here again, our precedent is conclusive: a risk of future adverse effects on benefits is not an injury in fact,” the appellate court’s opinion says.

DC plan claims

The 3rd Circuit also said the District Court correctly dismissed counts one through four insofar as they pertained to the DC plans. It affirmed the District Court’s ruling, but in part for different reasons. The plaintiff alleged that after the transfer, some deferred compensation plan investment options were no longer available and fees and costs were higher. The court said the higher fees may have been accompanied by higher returns. “Although we draw reasonable inferences in [the plaintiff’s] favor, we do not interpolate allegations that are not in the complaint. On the complaint’s face, [the plaintiff] has not alleged that he was injured by the changes to the deferred compensation plan. Therefore, he lacked standing to assert Counts One through Four insofar as they pertained to that Plan,” the appellate court wrote.

The plaintiff’s allegations about the 401(k) plan differ from his allegations about the deferred compensation plan. He alleged that after the transfer from Siemens to Sivantos, his 401(k) funds were moved into investments that “charged considerably higher management fees” and “generated less return.” The appellate court noted that diminished returns in a DC plan are a concrete injury in fact, and because he alleged that the higher fees and lower returns damaged him before he rolled over his account to an IRA, he pled concrete injury in fact with regard to counts one through four related to the 401(k) plan.

However, the court turned to Renfro v. Unisys Corp., in which the plaintiffs alleged that the defendants breached their fiduciary duty under ERISA because they “inadequately selected a mix and range of [401(k)] investment options.” The Renfro plaintiffs pleaded facts including the kinds of options available and the funds’ risk and fee profiles. The plaintiff suing Siemens did not allege what investment options were available after the transfer or what fees they charged. Nor did he allege how, specifically, the pre- and post-transfer options differed.

“Renfro provides the road map for how to plead his claims, but [the plaintiff] ‘provided nothing more than conclusory assertions that [the fiduciary] breached its duty to prudently and loyally select and maintain the plan’s . . . investment options.’ Thus, he failed to state a claim in Counts One through Four with regard to the 401(k) Plan,” the appellate court found.

It also ruled that the plaintiff lacks standing on his failure to provide information claim, and his request for injunctive relief does not cure the problem. According to the appellate court, the plaintiff has not properly alleged a violation of an ERISA statutory duty. The plaintiff does not specify what provision of ERISA requires Siemens to provide him with its purchase and sale agreement with Sivantos, documents it relied on leading up to the sale, or documents demonstrating compliance with unspecified “safeguards.” The 3rd Circuit concluded that the plaintiff was not injured by Siemens’ decision not to provide documents that ERISA did not require it to provide.

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