PLANSPONSOR - December/January 2020 - 41

DB FOCUS
having to write checks. "
The investment vehicle holds a
special appeal for firms with highly paid
employees, such as medical and legal
practices. Because they are DB plans,
they provide for compensation deferrals
far larger than 401(k) plans do-limits
are set in terms of maximum retirement
benefits to be paid and, for 2020, stand at
$230,000 per year. Corporate tax deductions
against current income can therefore
be substantial, and accordingly they
have been fondly embraced among the
better-paid occupations.
Cash balance plans also can be quite
flexible in their design. " Sponsors can write
plan documents that create different categories
of employer contributions, " notes
Dan Kravitz, head of Kravitz Inc., a firm
consulting in plan design and investment,
owned by retirement provider Ascensus,
and headquartered in Los Angeles. " A
senior partner in a professional firm could
defer at the limit, while a younger partner
might receive a smaller contribution. "
Still, cash balance plans require more
tending than a 401(k) arrangement. Each
year-end, an actuary strikes a " mark to
market " -the plan's progress for the year
in accrued contributions and investment
expectations, via the ICR embedded in
the plan design, plus actual investment
experience-to determine over- or underfunding.
If there is a shortfall, the sponsor
can amortize and pay it over seven years.
But the realities of business can
accelerate funding. " Many employers
don't smooth the contribution and make
it up immediately, " says Kravitz. " If the
plan were underfunded, and one of the
partners in the business were to leave all
of a sudden, he would be entitled to the
full amount of his accrued benefits, and
the remaining partners would be on the
hook to make up the rest. "
" We have some plans, particularly at
law firms, where they will terminate the
plan every 10 years and set up a successor
plan, " says Brett Dutton, lead investment
actuary with Vanguard Institutional
Advisory Services in Valley Forge,
Pennsylvania. " They don't want the plan
to get too big and risky to the enterprise,
so they distribute the assets in trust to
the beneficiaries. "
While participants in 401(k) plans,
and most other investors, would typically
welcome strong financial markets,
participants in cash balance plans might
be less enthusiastic, being that their tax
benefits as owners might be infringed
upon. Returns better than the ICR likely
high-dividend equities. We implement
these with low-cost ETFs [exchangetraded
funds]-we want the ability to
make tactical adjustments throughout
the year, and, as we get closer to hitting
our return target later in the year, we may
want to add risk, or take risk off the table. "
" Rather than try to make large adjustments
to the investment allocations each
year to hit the ICR target, we design a
strategy that has a good chance of earning
In today's markets of low interest
rates and jumpy stock markets, how
to hit that target-call it 4%-with
certainty is a puzzle.
mean lower current contributions-and,
in turn, lower tax deductions. On the
other hand, a sudden 20% drop in the
markets might call for an inconvenient,
much higher contribution.
These mechanisms mean that cash
balance plans also call for an unorthodox
investment process. Because tax law
requires that the investment performance
be assessed year by year, the customary
long-term view to retirement investing
is often abandoned. And, ideally, returns
on the plan portfolio should be as close
to the ICR as possible-often a fixed rate
between 3% and 6%-and no more.
In today's markets of low interest
rates and jumpy stock markets, how to
hit that target-call it 4%-with certainty
is a puzzle. Michael Walton, a managing
director at Sage Advisory in Austin, Texas,
emphasizes the difficulty of meeting a
one-year goal, year after year. " We'd like
to achieve the ICR with only investmentgrade
fixed income, but in this low-yield
environment it can't be done.
" In our portfolios, we have a foundation
of core fixed income through cash
bonds, " he explains. " To earn additional
return, we go outside core into high-yield
bonds, preferred stocks and, depending
on the strategy, a small allocation to
that return over a market cycle, " Dutton
says. " We advise our clients that they are
going to see gains and losses, and we don't
swing levers every year to hit that return,
because it requires short-term predictions
that we generally caution against. "
" For plans that are highly taxoriented,
we invest only in fixed income, "
says Chris Petrosino, managing director
of quantitative strategies at Manning &
Napier, an investment management firm
in Fairport, New York, near Rochester.
" We want to minimize the risk of saddling
a sponsor with a large drawdown and unexpected
contribution. We make active portfolio
decisions on bond market sectors,
duration and credit quality, and express
those through ETFs. While we may start
a year at a portfolio yield that may not hit a
particular ICR, we think it makes sense to
be flexible and take the opportunities that
the market may offer, rather than trying
to force a return through too much risk. "
Looking ahead into 2020, Petrosino
notes that the Treasury yield curve is still
rather flat, " and we don't see much reward
for taking risk in longer-duration bonds.
We also don't see compelling opportunities
in credit risk, so at the moment we
are conservatively positioned. But the
[new] year is young. " -John Keefe
PLANSPONSOR.COM December 2019 - January 2020 41
http://www.plansponsordigital.com/plansponsor/december-january_2020/TrackLink.action?pageName=41&exitLink=http%3A%2F%2FPLANSPONSOR.COM
PLANSPONSOR - December/January 2020

Table of Contents for the Digital Edition of PLANSPONSOR - December/January 2020
