Bottom Line Up Front

• New England’s biggest demographic challenge isn’t overall poulation decline — it’s an aging population and shrinking school-age population. These shifts are already changing service deamnds, workforce availability, and long-term budget planning.
• Declining enrollment and rising senior-related costs are creating a fiscal squeeze for many municipalities. School costs don’t fall as quickly as enrollment, while demand for services such as EMS, transportation, and senior support continues to grow.
• Communities that begin planning now will have more flexibility later. Long-range financial forecasts, capital plans, and pension/OPEB funding strategies should account for multiple demographic scenarios rather than assuming historical growth patterns will continue.

For years, many municipalities across New England have planned around familiar financial pressures: healthcare costs, infrastructure needs, pension/OPEB obligations, and state aid uncertainty.

But another long-term challenge is beginning to sit underneath all of them — demographics.
Communities across the region are getting older. Birth rates continue to decline. K-12 enrollment is shrinking in many districts. In some areas, population growth has slowed enough that local governments may soon find themselves maintaining infrastructure and services built for communities larger than the populations they actually serve.

None of this happens overnight. That’s part of what makes it easy to underestimate.

But over time, these shifts can begin influencing everything from school budgets and capital planning to emergency services, staffing, housing demand, and long-range financial stability.

The Pressure Isn’t Just Population Decline — It’s Population Composition

New England’s projected population decline over the next few decades is relatively modest overall. But the composition of that population is changing in ways that carry major implications for municipalities.

Many northern New England states are projected to have more than 25% of their populations aged 65 and older by 2030. Maine already has more seniors than children. At the same time, school-age populations continue to decline across much of the region.

Source: U.S. Census Bureau; UMass Donahue Institute; Cooper Center/UVA 2024 projections

That creates a difficult balancing act for local governments. Demand for senior services, emergency response, accessibility improvements, and healthcare-related support continues to rise, while enrollment-driven aid and long-term labor force growth may move in the opposite direction.

For municipalities, this is not simply a “growth versus decline” conversation anymore. It is increasingly a conversation about how communities adapt financially and operationally to an aging demographic profile.

Enrollment Decline Creates Financial Pressure Faster Than Many Communities Expect

One of the most misunderstood aspects of demographic decline is the assumption that falling enrollment automatically reduces costs.

In reality, many school district expenses remain relatively fixed regardless of how many students are enrolled.

Buildings still need maintenance. Transportation routes still exist. Administrative structures remain in place. Utilities, facilities, and operational overhead do not disappear proportionally alongside enrollment.

As enrollment declines, those costs become spread across fewer students, often driving higher per-pupil spending even without major new spending decisions.

Some areas of Massachusetts are already projected to experience significant long-term enrollment declines, particularly in western portions of the state.

The implications extend beyond operating budgets. Declining enrollment can eventually affect Chapter 70 education aid, though often with a lag that temporarily masks the underlying trend. Municipalities relying too heavily on current aid levels may find themselves planning future budgets on assumptions that gradually weaken over time.

These pressures rarely arrive all at once. They accumulate slowly — which is part of what makes them easy to underestimate early on.

Aging Communities Change Municipal Service Demand

As communities age, the types of municipal services residents rely on begin to shift.

Many municipalities are already seeing growing demand for:

• EMS and emergency response
• transportation accessibility
• senior programming and support services
• public health coordination
• accessible infrastructure and facilities

At the same time, aging populations can create additional strain on municipal budgets through rising healthcare costs and long-term benefit obligations.

This becomes especially important in communities where tax base growth is slowing or where working-age population growth has flattened. Over time, municipalities can find themselves facing growing service demands while revenue growth becomes more constrained.

That dynamic is one reason demographic planning is becoming increasingly important within long-range financial forecasting.

Immigration Is Becoming One of the Largest Unknown Variables

Historically, municipalities could often rely on relatively stable assumptions around long-term population growth.

That is becoming more difficult.

Nationally, the United States is approaching a demographic turning point where deaths are projected to outpace births, making immigration an increasingly important driver of population growth.

For Massachusetts specifically, immigration has become one of the most significant variables influencing future population projections.

The challenge is volatility.

Changes in federal policy, economic conditions, and migration trends can materially alter long-range population outlooks in ways local governments cannot directly control. That makes single-scenario forecasting increasingly risky for municipalities trying to plan capital projects, staffing, school infrastructure, and long-term liabilities over multi-decade time horizons.

Pension and OPEB Obligations Become More Difficult in Slower-Growth Environments

Demographic trends also influence the long-term sustainability of pension and OPEB obligations.

When municipalities face slower population growth, aging communities, and more constrained tax base expansion, funding long-term liabilities can become increasingly difficult over time.

This does not necessarily create immediate crisis conditions. But it does reduce flexibility.

Municipalities may eventually find themselves balancing:

• higher retiree-related costs
• slower revenue growth
• increasing service demands
• deferred infrastructure needs
• long-term pension and healthcare obligations

all at the same time.

That is one reason proactive planning matters, particularly for municipalities evaluating their OPEB funding strategy and long-term retirement obligations. The earlier municipalities begin stress testing long-range assumptions, the more options they typically retain.

The Municipalities That Adapt Early Will Likely Be Better Positioned Later

Demographic shifts are challenging precisely because they happen gradually.

There is rarely a single moment where the pressure suddenly becomes obvious. Instead, municipalities often experience years of incremental changes that slowly compound:

• slightly lower enrollment
• slightly older populations
• slightly slower tax base growth
• slightly higher service costs

Over long periods of time, those incremental shifts can materially reshape municipal financial conditions.

The communities best positioned to navigate those changes will likely be the ones that begin planning before the pressure becomes acute.

That may include reevaluating long-range financial assumptions, aligning capital planning with future demographic realities, monitoring enrollment trends more closely, stress testing pension and OPEB funding strategies, and exploring opportunities for regional collaboration where appropriate.

The advantage municipalities still have today is time.

Explore the Full White Paper

Odyssey Advisors’ white paper, Current Demographic Trends and Impact on Municipalities in New England, explores these demographic and fiscal trends in greater depth, including regional projections, enrollment data, funding considerations, and long-range planning implications for municipal finance leaders.

Download the full white paper here

The post The Demographic Shift Quietly Reshaping Municipal Budgets appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Even when retirees appear to pay the “full premium,” governments may still be providing a hidden OPEB subsidy through blended healthcare rates. 
• GASB 75 and ASOP 6 require actuaries to measure retiree healthcare costs using age-adjusted claims closets rather than blended premiums, which can significantly increase reported OPEB liabilities. 
• Ignoring implicit cost can materially understate a government’s OPEB liability, annual expense, and long-term financial obligation, creating audit, funding, and credit rating risks. 

When an employer provides retiree health benefits, the actual cost of those benefits typically varies by age. Older retirees generally use more healthcare and cost more to cover. If the employer charges all retirees (and often active employees) the same “blended” premium regardless of age, something subtle happens: the younger, healthier members of the group are subsidizing the older, higher-cost members.

Under Governmental Accounting Standards Board Statement No. 75 (GASB 75), and the actuarial guidance in ASOP 6,  this subsidy is not considered free. It has a real economic cost to the employer that must be measured and disclosed. That hidden cost is known as the implicit rate subsidy, often referred to simply as the implicit cost. 

What is the Implicit Rate Subsidy?

Here’s how it works in practice.

The actuary calculates what it would charge each age group if they were priced separately using age-adjusted or experience-rate costs. For example, a 62-year-old retiree might actually cost $1,800 per month to insure. However, the employer may only charge the retiree the same blended premium charged to everyone else – let’s say $900 per month. 

The retiree is therefore paying far less than their actual cost. The employer is absorbing the difference, even if it never writes a check to the retiree directly. GASB 75 requires actuaries to recognize this gap as part of the OPEB liability.

ASOP 6 reinforces this by directing actuaries to use age-adjusted costs when projecting future benefits, rather than simply projecting the blended rate. This ensures that the subsidy embedded within the premium structure is not overlooked. 

For a broader overview of implicit subsidies in OPEB plans, read our article here: Implicit Subsidies in OPEB Plans

A Simple Illustration

The graphic below shows how an employer can be providing a significant OPEB subsidy even if it believes retirees are paying “the going rate”. 

The active employee overpays relative to their age-adjusted cost, while the retiree underpays relative to theirs. The employer silently absorbs the gap between the two. That gap is the implicit cost, and both GASB 75 and ASOP 6 require it to be measured and
disclosed rather than buried in the blended premium. 

How GASB 75 Measures the Implicit Cost

GASB 75 measures the implicit costs through a specific actuarial process. At its core, the standard requires OPEB liabilities to be measured using the “entry age” actuarial cost method and mandates that the per capita claims costs used in the valuation be age-adjusted – not simply the blended premiums charged by the employer.

1. Determine age-adjusted per capita costs 

Following ASOP 6 guidance, the actuary develops what it would actually cost to provide healthcare for each age cohort separately. These costs are typically derived from insurance carrier data, published age-adjustment factors, or plan experience. 

For example, a 64-year-old retiree may have an expected healthcare cost of $1800 per month, while a 45-year-old active employee costs $450 per month, even if both individuals are charged the same $900 blended premium. 

2. Project those costs forward

The age-adjusted costs are then projected forward using healthcare trend rates, which reflect expected medical inflation over time. GASB 75 requires explicit healthcare trend assumptions, and those assumptions may differ by category of expense such as hospital services, physician services, or prescription drugs. 

3. Calculate the Total OPEB Liability (TOL)

Using the entry age method, the actuary attributes the projected value of each employee’s future benefits across their working career as either a level percentage of pay or level dollar amount. 

This produces the Total OPEB Liability (TOL), which represents the  present value of all benefits earned to date. The liability is discounted at either: 

• the expected long-term investment return for funded plans, or
• a municipal bond index rate for unfunded plans.

4. Where the Implicit Cost Appears: 

The implicit cost becomes visible when age-adjusted costs are used instead of the blended premium structure. Because retiree healthcare costs are significantly higher than the blended premiums often charged to retirees, the projected future benefit payments become materially larger than a simple “project the premium” approach would suggest. That increase in projected future costs directly increases the TOL.

In other words, the increase in the TOL resulting from age-adjusted costs is the recognition of the implicit subsidy embedded within the premium structure. 

5. Required Financial Statement Disclosure

GASB 75 requires governments to report:

• The Total OPEB Liability (TOL), 
• The Net OPEB Liability (TOL minus any plan assets), and 
• Related deferred inflows/outflows 

Directly on the face of the financial statements rather than solely in the footnotes, as was common under GASB 45. 

This makes the implicit cost visible to bondholders, taxpayers, and oversight bodies in a way it previously was not. 

Why Many Governments Were Surprised

Many governments believed they had relatively small OPEB obligations because retirees were paying what appeared to be their “fair share” of premiums. 

However, GASB 75’s age-adjusted measurement framework reveals that the blended premium structure itself is a form of benefit with a measurable and potentially very large present value. Because of that, many governments were surprised by how much their OPEB liabilities grew when they adopted GASB 75. 

What Happens If the Implicit Cost Is Ignored?

When the implicit cost is ignored, the OPEB liability is systematically understated. However, the consequences ripple further than just a number on a balance sheet.

The Direct Measurement Error

If an actuary projects the blended premium instead of age-adjusted costs, the assumed retiree healthcare cost is understated. Since the Total OPEB Liability represents the present value of projected future benefits, understating the per-retiree cost directly understates the liability itself. 

For plans with large retiree populations or long post-retirement coverage periods, the understatement can be substantial — often ranging from 20% to 50% depending on the demographics of the group. 

The Downstream Financial Impact 

The understatement doesn’t stay isolated. It cascades through several related figures. 

The Net OPEB Liability (TOL minus plan assets) is understated by the same amount, making the government’s balance sheet look stronger than it truly is.

Annual OPEB expense is also too low, because the service cost component (the portion earned by employees during the current year) is calculated using the same flawed per capita assumptions. This means operating results are overstated year after year.

For governments that prefund OPEB obligations, actuarial contribution calculations may also be insufficient, leading to chronic underfunding that compounds over time as the retiree population ages and the true costs eventually become unavoidable.

The Long-Term Fiscal Impact 

The implicit subsidy generally grows as: 

• More employees retire, 
• Retirees live longer, and 
• Healthcare costs continue rising faster than general inflation.

Ignoring the subsidy therefore creates more than a one-time error. The gap between the reported liability and the true liability widens each valuation cycle. 

When the issue is eventually corrected – whether through an actuarial assumption update, auditor review, or change in methodology – the liability can spike dramatically in a single year, creating a fiscal shock that is much harder to manage than gradual recognition would have been. 

Audit and Compliance Risk

GASB 75 is explicit that age-adjusted costs must be used in measuring OPEB obligations. 

Auditors reviewing OPEB disclosures are expected to evaluate whether the actuary’s per capita claims cost development complies with ASOP 6 guidance. If blended rates are used without appropriate justification, the financial statements may be materially misstated. 

This can expose governments to: 

• Audit findings, 
• Restatements, and 
• Reputational concerns with bond rating agencies. 

The Rating Agency Dimension

Credit rating agencies such as Moody’s, S&P global ratings, and Fitch Ratings all incorporate OPEB liabilities into their analysis of government creditworthiness. 

An understated OPEB liability can mask fiscal stress that rating analysts may identify independently through their own adjustments and modeling. 

Governments that understate their OPEB obligations do not necessarily fool the market – they just make their disclosures less credible. 

Why Implicit Cost Matters

Ignoring implicit cost is not a conservative accounting choice, it’s an error that defers recognition of a real obligation. 

The cost of providing healthcare to an aging retiree population does not disappear simply because the premium structure obscures it. GASB 75 exists precisely to prevent governments from treating a hidden subsidy as if it were not subsidy at all. 

Additional Resources 

For readers looking for a deeper technical discussion of implicit rate subsidies in OPEB plans, the Society of Actuaries has published additional guidance and analysis here:

Accounting for the Implicit Rate Subsidy in OPEB Plans (SOA PDF) 

Related Reading

• Understanding Implicit Subsidies in OPEB Plans
• Difference between GASB 74 and GASB 75
• OPEB valuation services 

Understanding how implicit cost impacts your OPEB valuation is critical for accurate financial reporting under GASB 75. If your organization is evaluating retiree healthcare obligations, reviewing actuarial assumptions, or preparing for an upcoming valuation, Odyssey Advisors can help you better understand how these liabilities are being measured and disclosed. 

The post How GASB 75 Measures Implicit Cost in OPEB appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Defined Benefit (DB) plans are built around the outcome. You’re promising a set retirement benefit. Defined Contribution (DC) plans focus on what goes in, but the final result depends on investment performance. 
• The biggest difference comes down to who takes on the risk: DB plans place investment and longevity risks on the employer, while DC plans shift those primarily to the employee. 
• Choosing the right plan depends on your budget, workforce, and long-term goals (and in many cases, a combination of both might make the most sense).

When it comes to retirement plans, most employers—and employees—are working within one of two structures: defined benefit (DB) plans or defined contribution (DC) plans. 

Over the past several years, we’ve seen a clear shift. In the private sector, DC plans have become the standard, while DB plans remain more common in the public sector. According to the U.S. Bureau of Labor Statistics, only about 15% of private industry workers had access to a DB plan as of March 2023, compared to 67% with access to a DC plan.

But beyond the trends the real difference between these plans comes down to one core question: who is responsible for the outcome?

The Core Difference: Promise vs. Contribution 

At a high level, Defined Benefit plans promise a specific benefit at retirement, typically based on years of service and pay, with the employer responsible for funding that promise. Defined Contribution plans set the contribution amount upfront, but the retirement benefit depends on how much is saved and how investments perform. 

That distinction drives everything else: risk, funding, predictability, and even how employees experience their retirement plan over time. 

What is a Defined Benefit (DB) Plan?

A retirement plan that promises a specific benefit at retirement, typically based on a formula 

That formula usually includes: 

• Years of service 
• Final average compensation 
• A benefit multiplier

From the employee’s perspective, the biggest advantage is predictability. From the employer’s perspective, it comes with responsibility. 

The employer (or plan sponsor) is on the hook for funding the plan, managing investments, and making sure the promised benefit can actually be paid. Because of that, contributions can fluctuate depending on the market and actuarial assumptions, and ongoing actuarial valuations are required. 

You’ll most commonly see DB plans in the form of traditional pensions or cash balance plans, which are a more modern, hybrid version of the same concept. 

A Note on Modern DB Plans: Cash Balance Plans

While traditional pension formulas still exist, many employers today are adopting a more modern “hybrid” version of a defined benefit plan known as a Cash Balance Plan.

Cash Balance plans are still DB plans at their core, but they’re structured in a way that often feels more familiar to employees. Instead of a lifetime annuity being the focus, benefits are typically expressed as a growing account balance made up of: 

• Annual pay credits
• Interest credits

That design can make the plan easier to understand, while still allowing employers to offer significantly higher contribution levels, especially for business owners, than a standalone defined contribution plan. 

What is a Defined Contribution (DC) Plan?

A defined contribution (DC) plan takes a different approach. Instead of promising a future benefit, it defines the contributions going into the plan. 

The final outcome is driven by:

• Contributions
• Investment performance
• Fees

There’s no guaranteed income at retirement, which means the responsibility shifts more toward the employee. 

Participants are making investment decisions, managing their savings rate, and ultimately absorbing the impact of market ups and downs. 

Plans like 401(k)s, 403(b)s, and 457 plans fall into this category. They’re generally easier for employers to administer and offer more cost predictability, which is one of the main reasons they’ve become so widely adopted.

If you’re evaluating or redesigning a plan, this overview of 401(k) plan design walks through the key decisions that actually shape how the plan functions. 

Side-by-Side Comparison

While both types are built to support retirement, they do it in fundamentally different ways.

When Each Plan Type Makes Sense 

Defined benefit plans tend to align well with organizations that have a stable, long-tenured workforce and a desire to provide predictable retirement income. They can also be a powerful tool for high-income business owners looking to defer more for retirement, particularly when structured as cash balance plans. 

Defined contribution plans are often a better fit for organizations that want more control over annual costs or have a workforce that values flexibility and portability. They also tend to resonate with employees who prefer having direct control over how their retirement assets are invested. 

What to Consider Before Choosing a Plan

Choosing between a DB and DC plan isn’t just about how they work, but how they fit into your overall strategy.

A few things to think through: 

• Cost predictability vs. variability: DB plans can introduce year-to-year contribution swings, while DC plans are typically more stable.
• Risk allocation: DB plans place investment and longevity risk on the employer; DC plans shift that risk to employees. 
• Workforce dynamics: Long-tenured teams may value DB plans more, while mobile workforces often prefer DC plans. 
• Administrative complexity: DB plans require actuarial oversight and more governance; DC plans are generally simpler. 
• Long-term financial impact: DB plans create ongoing liabilities, while DC plans limit obligations to annual contributions. 

Can You Offer Both?

In many cases, this isn’t an either/or decision because defined benefit and defined contribution plans can be complimentary with many employers offering both. 

This structure can: 

• Allow business owners to contribute significantly more toward retirement
• Provide meaningful, competitive benefits for employees 
• Balance long-term retirement security with flexibility

Where to Go From Here

The right approach comes down to aligning your plan with your organization’s financial capacity, workforce needs, and long-term goals. Whether that’s a defined benefit plan, a defined contribution plan, or a mix of both, the goal is the same: creating a strategy that works in practice, not just on paper. 

If you’re thinking through what the right plan looks like for your organization, or whether a defined benefit, defined contribution, or hybrid approach makes the most sense, it’s worth having that conversation early. 

If you want a second set of eyes on your current plan or are exploring your options, we’re always happy to talk through it.

The post DB vs. DC Plans: Navigating the Strategic Tradeoffs appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Making contributions to your company’s 401(k) plan and then transferring the balance to a Roth 401(k) can allow you to increase contributions and help decrease your taxes.
• In 2026, a participant can contribute up to $24,500 from their pre-tax earnings and up to $47,500 after taxes into their 401(k) plan for a total of up to $72,000 (indexed) — not including catch-up contributions.
• The Mega Roth Backdoor IRA can be effective under a plan with ideal demographics and generous employer contributions to save more in a Roth IRA or Roth 401(k) than you would normally be able to.

You know that Mega Backdoor Roth thing your friend mentioned or that you stumbled across online? The one where you can make substantial contributions to your employer-sponsored 401(k) plan and then transfer them to a Roth 401(k) essentially saving you more on taxes in the long run. It may sound too good to be true, but it can work wonders for those who qualify and are in the right plan. It’s especially helpful if you’d typically be unable to contribute to a Roth account due to exceeding income limits. 

The Logistics

Under the IRS Code, 401(k) plans have a variety of contribution limits (excluding catch-up contributions):

• Employee Deferral – $24,500 for 2026 (indexed)
• Maximum Account Addition – $72,000 for 2026 (indexed)

Beyond that, 401(k) plans have various non-discrimination rules to ensure that the plan does not overly benefit highly compensated employees (“HCEs”). As it relates to this situation, the key testing is the ADP/ACP test.

As an example – we have a small company with two (2) owners and five (5) employees. The plan has reasonable participation with the employees on average contributing 7.14% of their pay and an employer match of 50% up to 6.0% of pay deferred yielding a Non-Highly Compensated Employee (“NHCE”) Average Contribution Percentage (“ACP”) of 2.40% for our NHCE group.

Based on these figures our owner’s contributions of 9.08% as employees and the employer match ACP of 3.00% allows them to easily pass our ADP & ACP tests.

Now, let’s add an after-tax feature to our plan. The owners see that they are far from their $72,000 total contribution limit and they have additional money they’d like to save for retirement. Owner 1 contributes the full $38,500 of that potential $38,500 available to maximize their account to the after-tax source in the plan. It’s important to remember that after-tax contributions are treated as employer contributions for purposes of the ACP test.

So, let’s see what happens:

The ADP test still passes easily as there was no change. However, they now fail the ACP test and the Owner 1 will be required to take a return of $22,575 in excess after-tax contributions – that’s not going to be a pleasant conversation for the TPA to have with them.

So, what’s the big deal? I put money in, and I get it back if we fail?

Well, let’s remember the objective here. You were putting money into the after-tax source with the goal of immediately converting it to a Roth either within the plan or via an in-service distribution to a Roth IRA. Well, that conversion/rollover would be ineligible and would need to be disgorged from their account – and you thought the 1st TPA conversation with Owner 1 was going to be rough!

Bottom Line

The Mega Backdoor Roth can and does work. But you need to have ideal demographics and likely a very generous employer contribution to the plan. If so, this can be a great benefit.

The short answer – talk to your TPA or consultant, evaluate the demographics and objectives, and do a preliminary ACP test in advance to see if it will work.

If you’d like to know more, you can reach out to us here. We’d be happy to help answer any questions you may have.

The post Mega Backdoor Roth & After-Tax Contributions in Your 401(k) Plan appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Cash Balance plans enable high-income self-employed individuals, particularly those over 40, to supercharge their retirement savings beyond what traditional plans allow.
• Contributions are fully tax-deductible, creating immediate tax savings.
• While powerful, these plans come with strict funding obligations, administrative costs, and complex compliance rules, making them ideal for those with stable income and a long-term mindset.

When you’re self-employed, you’re in charge of everything – from client work to finances to your future retirement. And unlike traditional employees, you don’t have a built-in retirement plan waiting for you. That makes it even more important to find tax-smart, high-impact savings tools. One option that’s gaining traction among high-earning business owners? The Cash Balance Plan.

So, What Is a Cash Balance Plan?

Think of it as 401(k)’s sophisticated cousin. It looks like a retirement account with a balance that grows over time, but it’s actually a type of defined benefit pension plan with a modern twist.

Here’s how it works:

• You (as the employer) contribute a pay credit each year. This can be a percentage of pay or a fixed dollar amount (e.g., 25% pay for owners, 3% for others).
• Then, the account earns an interest credit, a guaranteed rate defined in your plan document. It might be a fixed rate or tied to something like U.S. Treasury yields.
• While it feels like a personal retirement account, it’s actually a company-funded benefit governed by specific pension rules.

Bottom line: You get the structure of a pension with the transparency of an account-based plan.

Why Cash Balance Plans Work So Well for the Self-Employed

1. Higher Contribution Limits – Especially As You Age

If you’re over 40 and looking to make up for lost time, a Cash Balance Plan (CB Plan) offers much higher annual contribution limits than IRAs or Solo 401(k)s. Contributions are calculated using actuarial methods and increase as you age.

Here’s what that might look like:

(Actual limits vary based on income and plan design)

This makes it a standout option for late starters or those finally hitting their financial stride.

2. Major Tax Deduction Power

Contributions to a Cash Balance Plan are fully tax-deductible as a business expense. For self-employed professionals in higher tax brackets, such as doctors, attorneys, business owners, etc., this can lead to substantial savings. Since the contributions reduce your adjusted gross income (AGI), they may also improve eligibility for other tax benefits and deductions. A CB Plan not only helps build retirement wealth but also serves as a highly effective tax planning tool, lowering your immediate tax liability while increasing long-term savings.

3. Catch-Up Power for Late Savings

Many entrepreneurs spend their early years reinvesting profits or weathering financial ups and downs. Saving for retirement typically takes a back seat. As a result, many find themselves in their 40s or 50s with a strong income but a sizable gap in their retirement planning. If you’re in a more stable position but feel behind on your retirement planning, a CB plan can help you catch up fast, especially if you’re aiming to retire in the next 10-20 years.

4. Can Be Paired with a Solo 401(k)

One of the best-kept secrets? You don’t have to choose between plans.

One highly effective strategy used to help self-employed individuals save for retirement is pairing a CB plan with a Solo 401(k) or profit-sharing plan. This approach allows you to maximize your retirement savings across two different vehicles. Together, they can push your total annual retirement contributions well over $300k – $400k, depending on your age and income.

Heads up: When using both plans together, the IRS combined plan limit comes into play. This rule typically caps employer contributions to defined contribution plans to 6% of pay when paired with a Cash Balance plan. So while it may slightly reduce what you can contribute to your 401(k), you’ll still unlock a much larger deductible contribution through the CB plan.

Not only does this dramatically increase your retirement nest egg, but it also provides substantial tax relief in the current year. That’s a powerful one-two punch: accelerated savings and reduced tax liability.

What You Should Know Before You Dive In

These plans aren’t for everyone. They work best for those who have:

• Consistent income
• A long-term view
• The willingness to follow the rules (or have someone help you do so)

These are the things you should consider:

Ongoing Funding Requirements

Cash Balance plans come with strict ongoing funding requirements that distinguish them from more flexible retirement options, such as 401(k)s. Since CB plans are a type of Defined Benefit plan, you’re obligated to contribute an amount each year based on actuarial calculations designed to meet the promised benefit at retirement. 

Contributions must be made consistently to stay compliant and cannot be skipped without potentially facing IRS penalties or plan disqualification. Annual funding must meet minimum thresholds, and underfunding in one year may require catch-up contributions in future years.

More Administrative Complexity (But It’s Manageable) 

Yes, these plans are more complex than an IRA. You’ll need: 

• An actuary to calculate annual contributions 
• A third-party administrator (TPA) for compliance testing and filings
• Annual IRS filings like Form 5500 

But here’s the thing: Most high-income business owners feel the tax and savings benefits far outweigh the admin fees, especially with the right team in your corner. 

Lots of Rules = A Need for Pros

Since Cash Balance plans are a type of Defined Benefit pension plan, they are governed by a web of IRS and Department of Labor regulations. They must comply with the rules that apply to DB plans, such as nondiscrimination testing, minimum funding standards, and benefit accrual limits. Trying to DIY this would be like doing your own root canal. 

Additionally, these plans need to be formally documented and amended as needed to reflect regulatory updates. An annual Form 5500 filing will also be required. CB plans also have strict rules regarding how and when benefits can be distributed, including required minimum distributions and vesting schedules.  

That’s why most self-employed folks work with retirement plan experts (like us) who specialize in small business and self-employed solutions.

Is a Cash Balance Plan Right for You?

For the right self-employed, high-earning business owner, a Cash Balance Plan could be the most powerful retirement tool you haven’t considered yet. While it’s not a fit for every business owner, those with the income and stability to fund it can be a total game changer. 

Let’s Talk Strategy

At Odyssey Advisors, we’ve helped countless self-employed professionals design and manage Cash Balance Plans that fit their goals and cash flow. If you’re curious about what your retirement picture could look like, let’s explore it together. 

The post Are Cash Balance Plans a Good Option for the Self-Employed? appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Develop a retirement plan with a financial advisor or retirement expert, and diversify both your asset allocation and asset location to protect and grow your savings effectively.
• Investing frequently, even in small amounts, will help you leverage compound interest and build a substantial nest egg over time.
• Resist the urge to time the market or frequently trade, and avoid early withdrawals to ensure you maintain steady growth and minimize setbacks.

Transitioning into retirement can feel overwhelming, especially when you consider the shift from saving to spending money. It’s a significant life change, and feeling a bit uncertain is completely normal. After years of diligently saving, you might be wondering how to protect your retirement savings. Here are 4 strategies to help you get started: 

1. Have a Plan

According to a study done by Northwestern Mutual, over 50% of people have no plan for their retirement savings. 

If you don’t know how much you need to save, you take a huge risk of not “getting there.” The Median American household has $164,000 in retirement savings according to the Federal Reserve’s 2019 wealth survey. For most people, when combined with average Social Security income, that’s not enough to provide the retirement most hope for. 

Talk to a financial advisor to get a picture of what you need to save to achieve the retirement you want or use a free tool like this retirement calculator to get started. 

Even a vague idea is better than nothing and lets you start planning how much you need to contribute now to achieve your goals. 

2. Diversify

Everyone talks about diversification, but many people focus on spreading their investments across different types of assets and forget the importance of spreading those investments across different accounts or locations.

Asset Allocation

Asset allocation is a key aspect of protecting retirement savings. Having the right mix of asset classes (stock, bonds, cash, etc.) for your risk tolerance and time horizon, as well as a mixture of assets within each asset class can help you avoid large losses that may happen in an individual stock or bond as well as losses that may happen for an entire asset class (eg. a 25+% loss in the stock market during a recession). It’s so key that most people have heard it discussed many times before, however, the second layer of diversification is something that is often overlooked.

Asset Location

Asset location refers to the type of account that assets are held in; taxable, tax-deferred, or Roth. Asset location is a strategy that helps minimize the most guaranteed of “losses” to your retirement account… taxes. Having assets located in different types of accounts allows flexibility in your withdrawal strategy to manage taxes while still generating the income you need from the portfolio. Business owners have the added bonus of being able to manage employer contributions to a 401(k) and Cash Balance or other Pension plans in their asset location mix.

3. Focus On How Often You Invest 

For this one, we’re pulling advice from someone you’ve likely heard of before, Warren Buffett. Mr. Buffett’s investment philosophy emphasizes that how frequently you invest is more critical than the amount you’re investing. In a CNBC interview, Buffett advised that even if you can’t make large enough contributions, the key is to keep investing regularly, no matter how small the amount. He stated, “I think it’s the thing that makes sense practically all the time.” 

This approach leverages the power of compounding interest, where even small, consistent contributions grow significantly over time, building a substantial nest egg by retirement.  

4. Don’t Try to Time The Market 

A risk that investors pose to themselves is market timing and frequent trading in retirement accounts. Individual investors consistently underperform the stock and bond market average return. Estimates range from 1%-3% per year that individual investors underperform stock market benchmarks. 

Human psychology seems to cause us to buy high and sell low. We panic when markets are going down and sell, then buy back in after they have gone back up missing out on all the returns in between. To protect your retirement savings in the long run; figure out your risk tolerance, invest in a diverse portfolio of stocks and bonds, rebalance your asset allocation periodically, and don’t make changes to the plan based on recent market performance! 

If you want to actively invest in the stock and bond markets, making stock picks and timing the market, set aside some money in non-retirement accounts that you can play with without putting your retirement savings at risk.

Here’s a free tool to discover your risk tolerance: https://investor.vanguard.com/tools-calculators/investor-questionnaire/questions

5. Watch Out For Early Money Withdrawals

According to a Bankrate survey, 51% of people with retirement accounts reported that they have taken withdrawals from their accounts before retirement. Early withdrawals from retirement accounts will set back your progress toward your goal. To protect your retirement savings, make sure early and unplanned withdrawals from a retirement account are a last resort in financial emergencies.

You’ve Got This

 A slow and steady plan to reach your goals and a healthy dose of discipline to follow the plan will go a long way toward securing your dreams for the future. Diversify your accounts and investments, keep it simple, stick to the plan and you’ll set yourself up for a great future. If you have any questions, you can reach us here. We’re here to help.

The post 5 Ways to Protect Your Retirement Savings appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Setting up a 401(k) plan is affordable for small businesses, with initial costs ranging from $500 to $2,500 and the SECURE Act providing substantial tax credits. 
• Ongoing administration fees vary, and many businesses benefit from using a third-party administrator. 
• Offering a 401(k) plan is an effective tool for attracting and retaining employees, providing them and the business significant tax advantages and financial growth opportunities. 

As a small business owner, you might be curious about the expenses associated with offering a 401(k) plan to your employees. You might have even dismissed the idea, assuming that 401(k) plans are exclusively for larger companies due to their perceived high costs. However, this is not accurate. The cost of a 401(k) plan can vary significantly based on factors such as company size, plan complexity, investment choices, and associated fees. Today, many 401(k) plans are quite affordable. In this article, we will delve into the specifics of these costs. 

You can use our guide to a 401(k) plan to learn more about these plans and how they can greatly benefit you and your employees. 

Please note that the information provided in this article is not intended as legal advice or a comprehensive interpretation of ERISA or any other applicable laws. It should not be misconstrued as financial or investment advice. Always consult with a qualified professional for legal, financial, and investment guidance specific to your circumstances.

Initial 401(k) Set-Up Costs

Setting up your 401(k) plan typically costs between $500 and $2,500, which is known as your one-time startup fee. These fees cover the cost of working with a retirement plan specialist in order to design the plan. Other costs associated with the plan’s set-up are establishing a recordkeeping system to keep track of contributions and transactions. You will also need to provide educational materials to help employees understand the features of the new 401(k) plan.

However, there is a tax credit available to small companies that are initially starting a 401(k) plan: 

1. When the SECURE Act 2.0 was signed into law, it included enhanced tax credits for small businesses of up to 50 employees who are starting a new 401(k) plan. However, it does phase out for businesses with 51 to 100 employees.

2. You can also earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan which is available for the first three years the feature is effective.
   

Now if combined, these credits can total up to $5,500 per year for a total of up to $16,500 for 3 years. 

401(k) Plan Administration Fees

401(k) plan administration involves annual fees paid to the plan administrator for managing the plan effectively unless you plan to handle these on your own. Many small businesses choose to hire a third-party administrator (TPA) to handle the day-to-day administration.

These administrators play a crucial role in maintaining your plan’s smooth operation. They handle various tasks, including recording participant contributions, managing investment choices, processing transactions, and conducting compliance testing to ensure the plan adheres to legal requirements. Additionally, administrators prepare annual statements, such as the Form 5500, and provide assistance for plan-related inquiries. 

Many of the plan administration fees come from: 

• Nondiscrimination testing
• Form 5500 
• Informational materials for employees 
• Annual statements 

The fees charged by third-party administrators can vary based on the plan’s size and complexity but typically fall within the range of $1,750 to $5,000 per year.

Employer Match Contribution Costs

You can also contribute a percentage of employee’s contributions to the plan. For example, an employer might match each dollar of the employee’s contribution up to 5% of their pay. Therefore if the employee earns $100,000 and contributes $5,000, then the employer will also contribute $5,000.

Although there is no law requiring employers to match employee contributions, most do as it is a way to build goodwill and loyalty with their employees. Another reason employers often contribute to the plan is to reduce taxes. Employers can deduct matched contributions from their income taxes. However, the IRS sets contribution limits each year for how much employees may contribute. For 2024, the 401(k) limit is $23,000.

Investment Fees

Investment fees are typically associated with the costs of managing and maintaining the investment options offered within the plan. Different investment options in the plan will have an expense ratio, which represents the percentage of assets deducted each year to cover operating expenses. 

There are other potential fees depending on the features of the plan, typically with more complex plans having higher fees. These fees are not typically paid by the employer, however as the employer your choice for plan asset provider will influence the fees employees will have to pay.

Tax Benefits of Starting a 401(k) 

So while a 401(k) plan is an investment, many small businesses are choosing to make the switch for the plethora of benefits. Aside from attracting and retaining employees, there are many tax benefits that can offset the total costs of the plan. 

The SECURE Act, passed in late 2019, increased the tax credits for small businesses (of up to 50 employees) to cover 100% of qualified start-up costs (up to a maximum of $5,000 per year for the first three years of the plan). 

And, as mentioned above, if you offer an employee match contribution, any match you make is tax-deductible. 

If you’re interested in learning more about how to get started, check out this step-by-step guide to starting a 401(k) plan. 

In Summary 

Long story short, offering a 401(k) plan is not only feasible for small businesses but also comes with several financial benefits. With the initial setup ranging from $500 to $2,500, and the SECURE Act providing substantial tax credits, especially for businesses with up to 50 employees.

If you’re looking to contribute more to your retirement plan, a 401(k) is the way to go. In fact, 401(k) plans offer the flexibility to contribute significantly more than other retirement plans. For an in-depth look at how you can maximize your contributions, especially through advanced techniques like cross-testing, read our article on 401(k) Cross-Testing.

As a specialized third-party administrator, we provide comprehensive services to streamline the setup and management of your 401(k) plan. Our expertise ensures compliance, efficiency, and maximized benefits for you and your business, allowing you to focus on growth while offering a valuable employee benefit. By partnering with us, you can leverage the full potential of a 401(k) plan without the administrative complexities.

Contact us today to learn how we can help you provide retirement benefits for your employees and stay ahead of the curve.

The post How Much Does it Cost to Start a 401(k) Plan? appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• Cross-testing is a strategic method in retirement planning that allows for the fair and tailored allocation of profit-sharing contributions, focusing on individual employee needs based on their age and compensation.
• This approach ensures higher contributions for older, highly compensated employees while maintaining fairness and compliance with regulatory standards, using methods like age-weighted and new comparability.
• The cross-testing method is most beneficial for companies with diverse employee demographics, particularly where older, higher-earning employees, like owners and key executives, seek to maximize their retirement contributions.

Cross-testing is a strategic calculation used by retirement plan sponsors to allocate discretionary profit-sharing contributions. It’s a popular choice, often combined with 401(k) and safe harbor contributions, to maximize annual contribution limits for owners while minimizing overall costs. This approach aligns with the goal of allowing owners and key employees to enhance their retirement savings effectively.

Understanding Cross-Testing

The core of cross-testing lies in considering employees’ ages, recognizing that older employees have less time to save and therefore need to allocate more towards their retirement savings compared to their younger counterparts.

How Does Cross-Testing Work?

Consider a simple analogy: a pizza party. Just as people have different appetites, employees have different retirement savings needs. ‘Big Eaters’ (older, higher-earning employees) desire a larger share of the retirement savings ‘pizza’, while ‘Little Eaters’ (younger, lower-earning employees) are content with smaller portions. Cross-testing ensures everyone gets a fair share relative to their ‘appetite’.

1. Big Eaters:  These are the employees who earn more money or are older and closer to retirement. They want a bigger piece of the retirement savings “pizza” because they are closer to retirement age or need more money when they reach retirement. 
2. Little Eaters: These employees are those who earn less money are younger and have more time before retirement. They’re okay with a smaller piece of the “pizza” since they don’t need as much right now and they have more time to save before retirement. 

In a regular retirement plan, everyone might get the same-sized slice of the “pizza,” which isn’t always fair. However, cross-testing helps make sure that different employees get a fair amount of retirement savings based on their individual needs and circumstances. 

Traditional Contribution Methods vs. Cross-Testing

Traditional contribution methods, like uniform or pro-rata allocation, often distribute retirement contributions equally or proportionally among all employees. Cross-testing, however, adopts a more nuanced approach. It considers factors like age and compensation, using benefit accrual rates to project the value of an employee’s retirement portfolio at retirement age, leading to a more equitable distribution of contributions. 

A cross-tested plan is most effective when your Highly Compensated Employees (HCEs) are of a higher age bracket compared to the rest of your employees. Given that owners typically fall into an older age group than a significant portion of their employees, this plan can be exceptionally advantageous. 

Key Concepts for Cross-Testing

Cross-testing retirement plans involves several key concepts that help ensure fiar and compliant allocation of contributions among different employee groups. Here are a few of those key concepts:

1. Employee Grouping: Employees are divided into distinct groups based on specific criteria, such as age, compensation, or job classification. These groups serve as the basis for determining how contributions are allocated.
2. Age-Weighted Method: Older employees receive higher contributions, reflecting their shorter saving period.
3. New Comparability Method: Different groups receive varying contribution rates.
4. Equivalent Benefits: A fundamental principle in cross-testing is that all employees, regardless of their group, receive an equivalent retirement benefit. Even though contribution amounts may differ, the retirement income replacement ratio is intended to be similar for all employees.
5. Non-Discrimination Testing: Retirement plans must pass nondiscrimination testing to ensure that they don’t unfairly favor highly compensated employees (HCEs). Cross-testing plans go through these tests to demonstrate compliance and fairness in benefit allocation. These tests make sure the retirement plan is fairly benefitting everyone by looking at how much each employee defers, company contributions to each employee’s account, and how much of the plan’s assets belong to the HCEs.
   • There are two annual nondiscrimination tests for 401(k) plans, the Annual Deferral Percentage (ADP) and the Actual Contribution Percentage (ACP) test.
   • For profit-sharing allocations, they will need to pass testing under IRC 401(a)(4) and IRC 410(b) – basically are benefits offered to a non-discriminatory group of employees and that the benefits do not overly benefit the HCE group.

Benefits and Advantages of Cross-Testing

Cross-testing allows for higher contributions to key employees and promotes fairness and compliance with regulations. It tailors contributions based on individual needs, benefiting those closer to retirement while still supporting younger employees. 

Real Life example (showcases the impact of cross-testing on contribution limits) 

Consider ABC Enterprises with two employees, Sarah (owner, higher salary, older) and Michael (younger employee, lower salary).

In a regular retirement plan without cross-testing, both Sarah and Michael might receive the same percentage of their salary as contributions, let’s say 5%. However, if ABC Enterprises uses cross-testing, they might group Sarah as an HCE and Michael as an NHCE which would allow for a more strategic allocation of contributions based on their needs. 

In this example, cross-testing has allowed ABC Enterprises to maximize contributions while staying within regulatory limits. Sarah benefits from the larger contribution percentage due to her age and income level and Michael receives a smaller contribution percentage, reflecting his longer time for the contribution to grow. 

It’s important to remember that these contributions must be tested for nondiscrimination annually under IRC 401(a)(4) and IRC 410(b) to ensure that the benefits do not overly benefit the HCE group. Before that testing may even be done, the contributions just pass a “gateway” test such that each NHCE must receive the lesser of ⅓ or 5% of the employer contribution made for any HCE.

Eligibility and Considerations for Cross-Testing 

When considering cross-testing for your defined contribution plan, you should evaluate factors like your employee demographics, owner/key employee objectives, contribution goals, budget, and company growth. 

1. Employee Demographics: Cross-testing works best when you have a diverse employee group with varying ages and compensation levels.
2. Owner/Key Employee Objectives: If you’re seeking to maximize your contributions as an owner or key employee, cross-testing can be beneficial. 
3. Contribution Goals: Cross-testing is ideal when you want to allocate contributions in a way that rewards long-serving employees or those closer to retirement, while still offering benefits to younger employees. 
4. Budget and Cost Considerations: Make sure to determine if the potential increase in contributions aligns with your budget and how it may impact your overall plan costs. 
5. Company Growth and Changes: Consider how cross-testing will adapt as your company evolves. Will it still be effective as your workforce grows or changes over time?

Implementing Cross-Testing

Implementing cross-testing in your retirement plan involves a structured process that starts with evaluating your plan’s unique needs and objectives. Here’s a simplified guide to help you get started: 

1. Assess your Employee Demographics: Begin by analyzing your employee population, considering factors such as age, compensation, and job classifications. Cross-testing works best if you have a diverse workforce with varying attributes. Identifying distinct employee groups will form the basis for contribution allocation. 
2. Design Your Plan: Work with retirement plan experts to design a plan that aligns with your goals and your employees’ needs. This includes selecting the cross-testing method that best suits your objectives, whether it’s age-weighted or new comparability. Ensure that your plan complies with IRS regulations and non-discrimination testing requirements. 

Remember to communicate the changes to your employees. Transparency and clear documentation are essential to ensure that your team understands how contributions are allocated and the potential benefits of their savings. 

To Sum It Up: The Importance of Cross-Testing in Modern Retirement Planning

Cross-testing is a powerful tool to maximize contributions while ensuring fairness and regulatory compliance. This method takes into account the diverse needs and circumstances of employees, recognizing that not everyone requires the same-sized “slice of the retirement savings pizza.” It’s increasingly relevant in today’s complex retirement planning challenges like rising healthcare costs and diminishing social security benefits. 

For personalized guidance on retirement planning and the benefits of cross-testing, contact our team of experts. We’re here to help you navigate retirement planning complexities and tailor solutions to your unique needs.

The post Maximizing Retirement Savings Through Cross-Testing: A Strategic Approach for Plan Sponsors appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• This article provides an overview of the different financial asset classes, including Domestic Equities, International Equities, Fixed Income, Alternatives, and Real Estate.
• Each asset class has its own characteristics and risk profiles. Domestic Equities vary in size and growth potential, while International Equities involve currency exchange risk. Fixed Income offers predictable payments, while Alternatives encompass a diverse range of investment types and Real Estate includes rental properties, REITs, and raw land.
• Understanding each asset class can help you make informed investment decisions and create a diversified portfolio based on your risk tolerance and investment goals.

From pension plans, OPEB plans, 401(k) plans, or personal investments many people are faced with the dilemma of understanding various types of financial assets. This article will help you start to understand what these asset classes are and some of their basic characteristics.

You can also check out our on-demand webinar on this topic as well: Understanding Asset Allocation

What is Market Capitalization?

Conversations about asset allocation will almost always contain terms like Market Cap, Large Cap, Small/Mid Cap, etc. I’ve had several conversations where people ask, “Why are Markets or Equities capped?” Whenever you see the word “Cap” in terms of asset allocation we aren’t talking about a maximum limit on assets, the term “Cap” is short for Capitalization. Market Capitalization means the total value of a company on a financial market. The formula for calculating the market capitalization of a company is the number of shares outstanding x the cost per share of that company. For example, the Market capitalization of Coca-cola:

• Number of shares outstanding – 4.3 billion
• Cost per share assumed – $60.00
• Market capitalization – 4.3 billion x 60 = $260 billion

Domestic Equity – Large Cap

Our first asset class is “Domestic Equity – Large Cap”. Domestic Equity means that this is a U.S.-based company and Equity means we are talking about their stock or ownership shares of the company. Large Cap means the market capitalization of these companies is “Large”. Large-cap is not a single definition, different professionals will have differing opinions on what classifies a company as “Large”. In general, a market cap of about $10 billion is considered large. Large companies are more likely to be household names as well. Some that you’ve probably heard of are Apple, Microsoft, Amazon, Coca-Cola… and so on.

What are some characteristics of large-cap companies?

They tend to have at least nationwide business operations and there’s a very good chance they have large international operations as well. In general, there is less room for rapid growth for these companies. They don’t have many large untapped markets they can move their products to. On the inverse side, these companies tend to have more stable earnings than smaller companies, so they are less likely to have extreme losses in revenue.

All of that backdrop leads to a projected return (based on the 2022 Horizon Survey of Capital Market Assumptions) net of inflation of:

Domestic Equity – Mid Cap

The market capitalizations for Mid Cap companies will, again, not vary based on who you ask. However, some general guidelines include: Mid Cap companies have a market cap of $2-$10 billion. Many of these companies are still household names, although fewer are in the Large Cap category. Some Mid Cap companies you may recognize are: Yet, Hostess Brands, Harley Davidson, B.J.’s Wholesale, Crocs, and Texas Roadhouse.

Mid Cap companies compared with Large Cap companies will tend to have slightly more earnings and share price volatility. One way that is measured is with “Beta” (which will also be referred to with just the Green alphabet letter “β”). Beta measures the increased volatility of a stock or index compared to another index (generally the S&P 500). A Beta of 1.1 means that whenever the S&P moves 1% up or down the corresponding stock or index will move 1.1% up or down. Thus, a Beta above 1 means increased volatility. The Beta for a Mid Cap market index is 1.08 showing that in general Mid Cap companies are more volatile than Large Cap meaning higher potential gains and higher potential losses come with the Mid Cap territory.

While smaller than Large Cap, Mid Cap companies will still have large operations and are likely to be nationwide operations and may have some international operations as well. These companies may have more room for rapid growth if they can expand to new markets.

Domestic Equity – Small Cap

The market capitalization for Small Cap companies is generally considered to be $250 million – $2 Billion. As you start looking through Small Cap company index lists fewer of the names become recognizable household names for most people. Some names you may know are Ethan Allen and Winnebago.

Small Cap companies will tend to have even more earnings and price volatility with a Beta of 1.13, meaning these companies will tend to have even higher potential for outsized gains or outsized losses. These companies tend to have more regional operations and may have untapped markets that they could break into, rapidly expanding their market value.

The projected return for Small/Mid Cap companies net of inflation is: 

International Equity – Developed Market

International Equity, first off, is stock ownership in non-U.S.-based companies. Developed markets mean that these investments will be in areas that have developed economies and financial systems. Examples of Developed Markets include England, Ireland, Australia, Germany, France, and Japan.

International Developed companies tend to have low social and political risk. In other words, these governments and social frameworks are unlikely to create a scenario where a company experiences major changes to its business for social or political reasons. One risk that is introduced is currency exchange risk. Currency exchange risk is the variability that comes from the relative value change between local and foreign currencies. For example, if you bought shares in a U.K.-based company in pounds you had to exchange dollars for pounds to make the purchase, then when you go to sell the investment, you need to exchange the pounds back into dollars. Not only are you experiencing the risks associated with a business over that time period, but your investment can also change in value because the dollar becomes more or less valuable compared to the pound.

The projected return for International Developed companies net of inflation is:

International Equity – Emerging Market

Emerging Markets are in countries that don’t have a long-established industrial and economic environment, but are on the path to being stable and established economies. Examples of emerging Markets include Brazil, Turkey, India, China, and South Africa.

These companies have a higher potential for political or social risk and currency exchange risk. The tradeoff is that there is potential for companies in these markets to experience very rapid growth through stabilizing social, political, or economic factors as well as lots of opportunity for companies to grow in undeveloped markets. The downside is that these companies have a higher risk of volatility and a higher risk of severe losses.

The projected return for International Emerging companies net of inflation is:

Fixed Income – Domestic and International

Our next class moves us away from the equities markets and into fixed income. Fixed-income securities have a fixed payment rate over the lifetime of the investment. Investments in this category include Bonds, Treasuries, CDs, and Preferred sales. All of these investments pay a fixed rate generally annually or semi-annually, over a certain time period. Domestic Fixed income invests in these investments in U.S.-based companies or municipalities.

There tends to be less risk in fixed-income investments because the payments to the investor are known rather than being based on the company’s performance like equity investments are. Fixed-income investors also tend to be paid first in the event of bankruptcy, so there is less risk of a total loss in the investment. Along with the decreased risk comes decreased expected returns.

International fixed income has the same characteristics but introduces currency exchange risk. There is also some diversification that comes from International fixed income as the “debt cycles” may be different for international companies and municipalities compared with the U.S.

The projected return for Domestic and International Fixed Income net of inflation is:

Alternatives

The next asset class to cover is Alternatives. This can be a tricky asset class because a lot of different investments are categorized as Alternatives. We’ll briefly go over some of the major Alternative investment types:

• Commodities – Metals, wood, animal or plant produce, oil, etc. Think gold, silver, and raw materials
  • Adds diversification to a portfolio
• Hedge Funds – An investment vehicle that generally uses long and short positions to achieve a return in any market environment
  • Can invest in anything
  • Often have high expenses to cover active management
  • Can use leverage
  • Can limit liquidity
• Limited partnerships – Business structure often used to facilitate investments in private companies
  • Access to non-publicly traded companies and business opportunities
  • Low liquidity
• Private Equity – Invest in private businesses, often focused on buyouts or buying struggling businesses to turn them around
  • Access to non-publicly traded companies and business opportunities
  • Often use leverage to increase returns, also increasing risk
  • Low liquidity
• Venture Capital – Invests mostly in startup companies that are not publicly traded with the goal of seeing a few become large publicly traded companies
  • High potential returns and losses
  • Low liquidity

The projected return for Alternatives net of inflation is:

Interested in learning more? Check out our previously recorded webinar with Kathleen Glowacki on Demystifying the World of Alternative Investments

Real Estate

Real estate can be broken into categories, for this summary, we’ll break it into three categories: Rental Property, REITs, and Raw Land.

The projected return Real Estate net of inflation is:

Putting all of these asset classes together we can create a hypothetical portfolio and show expected portfolio returns:

There is certainly much more that can be covered in the area of asset allocation. Hopefully, this has helped you get a better understanding of what various asset classes are and some of their characteristics. If you have any questions or if you have any asset allocation questions you’d like us to cover in another article, please let us know! You can reach us here.

The post Understanding Asset Allocation appeared first on Odyssey Advisors, Inc.

Bottom Line Up Front

• When determining the best OPEB funding strategies, you must consider all of your liabilities, funding tangibly important things like a new fire truck, new elementary, etc. which means we can’t give you a one-size-fits-all solution. 
• There are many different funding strategies available such as flat funding, annual increasing funding, post-pension funding, funding the service cost, and funding the Actuarially Determined Contribution (“ADC”). 
• We recommend working with your actuary and consulting with your auditor to develop customized funding scenarios to determine which are both sustainable and meaningful, in order to achieve long-term financial stability for the trust.

Municipalities from across the U.S. are struggling to fund their Other Post-Employment Benefits (OPEB) obligations. Rising healthcare costs and aging populations are exacerbating the problem, leading to budget shortfalls and potential credit downgrades. 

To address this challenge, many municipalities have established an OPEB plan trust in order to start pre-funding their plans. This can be very favorable as pre-funding allows for long-term investment and compound interest growth. But now you’re facing a new challenge – how much should you contribute to your trust?

How Much Should You Contribute to Your OPEB Plan Trust?

All of your problems will be solved with this one weird trick… fund the Actuarially Determined Contribution (“ADC”) from your OPEB report every year. There you go, next question. 

Is It Really as Simple as Funding the Actuarially Determined Contribution?

I promise you I’d tell you to stop reading now if it was, but there’s a reason I didn’t stop with that first question and it isn’t because I love writing. Sadly, like most things in municipal finance, there are a lot of things to consider when determining how much money should be diverted to funding an OPEB trust. 

Things like other liabilities, funding tangibly important things like a new fire truck, etc… The list is endless and you probably are juggling that all day so I won’t go on, but the takeaway is that the endless moving parts keep us from giving any kind of one-size-fits-all solution. 

Okay… So What Should We Do?

One of the goals in funding is to utilize a higher discount rate to determine the liability. On that front, it would be very tempting to shoot for the moon and commit to an unrealistic policy to get the highest discount rate possible. This has its own issues though. For one, your auditors may recommend a lower discount rate to be used and the rating agencies will take note of your failure to commit to the funding policy. On the flip side, if you fund whatever is leftover every year on an ad-hoc basis with no formal commitment or strategy, you will not reap the full benefits of a higher discount rate. 

The best bet is to commit to something that is realistically sustainable over time and meaningfully impacts the liability. Does that mean one year of undershooting the commitment will tank the discount rate and have you put on the rating agencies’ so-called, ‘naughty list’? No, life happens. A missed year here and there is unlikely to impact things, but a trend of bad years should lead to a conversation about revisiting the policy. 

Check out these 5 ways to reduce your OPEB liability

That’s a Whole Lot of Words for a Vague Non-Answer… Can You Give Us a Few Funding Examples?

I thought you’d never ask! Over the years we’ve seen interest in and the implementation of many different OPEB funding strategies. Here are some of the more popular ones:

• Flat Funding – Basically a set dollar amount that gets funded every year, for example, $500K per year beyond the pay-as-you-go cost until fully funded.  Many municipalities that do this will also put in extra funds if any but the amount they are committing to, and the amount used to determine the discount rate is $500K.
  
• Increasing Funding – Same thing as Flat Funding but the amount is set to increase every year.  If we go back to the $500K example, we might say the contributions will increase by an additional $10kk each year or contributions will increase by 3% per year.
  
• Post Pension Funding – If you have an underfunded pension plan that is currently being funded, there is likely a funding schedule that shows it reaching “full funding” at some future date. In Massachusetts, municipalities have a set year they expect to achieve full funding for their pension.  The idea here is that after the pension is fully funded some of the payments being made to the pension can be redirected to an OPEB Trust.  It is generally recommended to do some funding leading up to this year to show a commitment to solving the problem.
  
  For example, if a town is contributing $5 million annually to fund the pension which is expected to be fully funded in 2038, they may commit to $500K until 2038, then $4 million (80% of the pension contributions) be redirected to OPEB funding in 2039 and going forward until the OPEB liability is fully funded.  The advantage here is that it may allow the use of a much higher discount rate without materially affecting outgoing money in the short term.
  
• Funding the Service Cost – This is also known as “stop the bleeding”.  The idea here is to fund all new liabilities as they accrue while paying off past liabilities through benefit payments.  So every year you would contribute the Service Cost which is the future benefits accrued by all eligible active employees over the course of a year.
  
• Funding the ADC – This is a more aggressive version of funding the Service Cost.  On top of stopping the liability from growing by paying the Service Cost, you would pay an amortized amount of the prior or past service liability.

You’re probably wondering why funding the ADC wasn’t the first example listed, after all, it’s the “Actuarially Determined Contribution” right? It does seem like it was GASB’s goal to make this the gold standard in funding but as said before a one-size fits all solution doesn’t always work and we rarely see this OPEB funding strategy in practice.

Interested in learning more about pre-funding your OPEB plan: Here are the top 6 reasons to pre-fund your OPEB

How Do I Pick the Right OPEB Trust Funding Strategy?

Again, the goal here is to pick something that is both sustainable and meaningful.  $100 a year for a $50 million liability is certainly sustainable but definitely not meaningful.  $5 million a year is definitely meaningful but may not be sustainable.

At Odyssey Advisors, we understand the importance of finding the right funding solution to ensure the long-term financial stability of your trust. We recommend that you work with your actuary to come up with a few different scenarios to see what kind of change in liability you would get in each scenario.  Then look at the budget and perhaps ask your auditor for advice on which one (if any) fits best.

If you have any questions or need help developing customized funding scenarios, please don’t hesitate to contact us. Our team of experienced actuaries can work with you to identify the best strategies for your unique needs and circumstances. Let us help you navigate the complexities of OPEB funding and achieve your financial goals. Contact us today to get started today.

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