WHY YOU SHOULD KNOW ABOUT CASH BALANCE PLANS

Transcription

1 WHY YOU SHOULD KNOW ABOUT CASH BALANCE PLANS Presented by Steve J. Persons, MSPA, CPA Max E. Wyman, MSPA, CPC Creative Benefit Strategies, Inc. (800)

2 Why should YOU care about Defined Benefit or Cash Balance Plans? Many clients are looking for larger contributions Defined Contribution plan maximum for a participant is $53,000 ($59,000 if catch up eligible) By adding a CB to existing DC can often get substantially larger contributions for key employees at small cost for other employees If you aren t the one that advises your clients of the ability to get larger contributions by adding a CB, maybe your competitors will do it for you. If your competitors aren t advising their clients of these plans, maybe you can do it for them.

3 Defined Benefit Plans - General Why a Defined Benefit Plan (vs a DC plan)? Provides larger (additional) limits than DC plan (100 comp; $53,000 for 2016) Sample DB contributions: Age 40 $ 85,000 Age ,000 Age ,000 Age ,000 Age ,000 These amounts could be sustained for ~ 10 years Assumes adequate comp. to support maximum dollar benefit

4 Combined DB/DC Deductions IRC Section 404 Maximum greatest of Target Normal Cost (TNC) + Shortfall amortization TNC + Funding Target (FT) + Cushion - Assets Cushion generally 50 FT TNC + FT Assets as if plan At - risk Generally this is amount needed to fully fund benefits Combined plan limits if DB and DC 25 participant comp, ignoring first 6% to DC So 31 comp if all participants in DC Or maximum DB plus 6% to DC Limits do not apply if DB plan subject to PBGC coverage

5 OVERVIEW OF CASH BALANCE PLANS A Defined Benefit Plan 3-year Cliff Vesting PBGC Defined Contribution Aspects Lump Sums Combined CB/DC Plan Limits Combined Testing for Nondiscrimination Top Heavy

6 What is a Cash Balance Plan? Defined benefit plan Benefit = Notional account Assets are not divided into accounts Account is on paper only Interest credit on notional account E.g., 5% annual interest credit Assets invested independently of interest credits E.g., could invest in equities

7 CASH BALANCE PLANS HOW DO THEY WORK A Hypothetical Account is created for each participant Participants are credited with hypothetical contributions Percentage of compensation or flat dollar amount Hypothetical accounts are credited with interest each year Typically 30-year Treasury rates Under PPA regulations can be any fixed or variable rate that does not exceed a market rate Normal form of benefit is life annuity, but participants can elect to receive lump sums = to hypothetical account Employer contributions are based upon regular DB actuarial valuation may be higher or lower than hypothetical contributions

8 CB PARTICIPANT STATEMENT Beginning Balance $5,000 Contribution Credit $1,000 Interest Credit $ 250 Ending Balance $6,250 Vested Percentage 100% Vested Balance $6,250

9 Cash Balance Plans Why use a Cash Balance Plan (vs traditional DB)? Provides more meaningful (understandable) benefit to employee visa vi traditional DB plan Recall previous example statement looked like PSP statement Compare to statement from traditional DB plan where statement tells participant of monthly benefit payable sometime in future In professional groups more able to equalize benefits Or identify how much of plan belongs to each Avoid lump sum swings due to interest rate shifts Age neutral contributions for non-owners

10 CASH BALANCE PENSION PLANS ADVANTAGES Can provide key employees with much larger contributions than allowed in DC plans Can pick and choose which employees to give larger contributions Can provide owners with different ages equal contributions Much easier for employees to understand than traditional DB plans (Profit Sharing Type Statements) DB features with DC hypothetical account balances Participant accounts credited with guaranteed interest

11 CASH BALANCE PENSION PLANS DISADVANTAGES Required Contributions Requires an individually designed plan document Must benefit lesser of 40 Non-Excludable Employees or 50 (not less than 2 unless 1 participant plan) May require PBGC premiums (not applicable to professional firms with less than 26 active participants) Employer bears the investment risk Higher annual administrative cost

12 CASH BALANCE PLANS IDEAL FOR Employers who are older than some employees Employers wishing to have DB type plan but have some older employees that would cost too much in a traditional DB plan Employers wishing different contribution rates for different classes of employees Employers with stable income Employers with current Cross-Tested Plans that desire larger contributions

13 Conversion of a Traditional DB Current regulations require A + B A = DB accrued benefit at date of conversion including IRC 417(e) B = CB hypothetical account consisting of pay and interest credits after date of conversion Proposed regs asked for comments regarding set and forget DB accrued benefit at date of conversion converted to opening hypothetical account balance using IRC 417(e)

14 CASH BALANCE PLANS RULE OF THUMB IF CROSS-TESTING WORKS, CASH BALANCE WILL WORK

15 Cross-Tested Profit Sharing Plan Age Wages P/S Total Wages Owner ,000 53, % 20.00% Spouse 53 25,000 3, % 14.40% 290,000 56, % Staff ,500 1, % 5.00% Staff ,500 1, % 5.00% Staff ,500 1, % 5.00% Staff ,500 1, % 5.00% Staff ,500 2, % 5.00% Staff ,000 2, % 5.00% 202,500 10, % Totals 492,500 66, %

16 Cross-Tested 401(k) Plan Age Wages Deferrals PS Total Total Wages Owner ,000 24,000 35,000 59, % 22.26% Spouse 53 25,000 12,000 3,600 15, % 62.40% 290,000 36,000 38,600 74, % Staff ,500-1,625 1, % 5.00% Staff ,500-1,375 1, % 5.00% Staff ,500-1,875 1, % 5.00% Staff ,500-1,125 1, % 5.00% Staff ,500-2,125 2, % 5.00% Staff ,000-2,000 2, % 5.00% 202,500-10,125 10, % Totals 492,500 36,000 48,725 84, %

17 Defined Benefit Pension Plan Age Wages DB Total Wages Owner , , % 70.7% Spouse 53 25,000 17, % 70.0% 290, , % Staff ,500 10, % 33.0% Staff ,500 3, % 11.5% Staff ,500 33, % 89.2% Staff ,500 1, % 8.4% Staff ,500 21, % 51.3% Staff ,000 8, % 22.5% 202,500 80, % Totals 492, , %

18 Cash Balance Pension Plan Age Wages CB Total Wages Owner , , % 69.3% Spouse 53 25,000 9, % 39.5% 290, , % Staff ,500 6, % 21.0% Staff ,500 5, % 21.0% Staff ,500 7, % 21.0% Staff ,500 3, % 16.8% Staff ,500 8, % 21.0% Staff ,000 8, % 21.0% 202,500 41, % Totals 492, , %

19 Profit Sharing/Cash Balance Plans Doctor Wants Maximum in Profit Sharing Age Wages PS CB Total Total Wages Doctor ,000 53,000 78, , % 49.53% Spouse 53 25,000 1,000 3,125 4, % 16.50% 290,000 54,000 81, , % Staff ,500 2, , % 8.45% Staff ,500 1, , % 8.45% Staff ,500 2, , % 8.45% Staff ,500 1, , % 8.45% Staff ,500 2, , % 8.45% Staff ,000 2, , % 8.45% 202,500 14,074 3,038 17, % Totals 492,500 68,074 84, , %

20 401(k)/Cash Balance Plans Doctor Wants Maximum in 401(k) (31% Limit) Age Wages Deferrals PS CB Total Total Wages ,000 24,000 35,000 98, , % 59.25% 53 25,000 12,000 2,000 1,250 15, % 61.00% 290,000 36,000 37,000 99, , % 45 32,500-2, , % 7.95% 30 27,500-1, , % 7.95% 55 37,500-2, , % 7.95% 25 22,500-1, , % 7.95% 50 42,500-2, , % 7.95% 40 40,000-2, , % 7.95% 202,500-13,061 3,038 16, % 492,500 36,000 50, , , %

21 401(k)/Cash Balance Plans Maximum Total Contribution for Doctor (limit PS to 6%) Age Wages Deferrals PS CB Total Total Wages ,000 24,000 14, , , % 83.58% 53 25,000 12,000 1,450 3,750 17, % 68.80% 290,000 36,000 15, , , % 45 32,500-2, , % 8.45% 30 27,500-1, , % 8.45% 55 37,500-2, , % 8.45% 25 22,500-1, , % 8.45% 50 42,500-2, , % 8.45% 40 40,000-2, , % 8.45% 202,500-14,074 3,038 17, % 492,500 36,000 29, , , %

22 401(k)/Cash Balance Plans Maximum Total Contribution for Owner Both Plans (CB Plan covered by PBGC) Age Wages Deferrals PS CB Total Total Wages ,000 24,000 35, , , % 91.51% 53 25,000 12,000 1,250 6,250 19, % 78.00% 290,000 36,000 36, , , % 45 32,500-2, , % 9.45% 30 27,500-2, , % 9.45% 55 37,500-2, , % 9.45% 25 22,500-1, , % 9.45% 50 42,500-3, , % 9.45% 40 40,000-3, , % 9.45% 202,500-16,099 3,038 19, % 492,500 36,000 52, , , %

23 FLEXIBILITY Use the flexibility in the PS plan first Assuming maximum made in first year CB Range: Minimum Maximum Recommended Excess Year 1 $167,758 $201,333 $187,788 $20,030 Year 2 $150,590 $311,682 $187,788 $37,197 Year 3 $136,457 $426,726 $187,788 $51,330 Other ideas to add more flexibility CB contributions = Percentage of pay Use an excess only allocation formula Make larger CB contributions in year 2

24 FLEXIBILITY Contribution Timing Recommend advance funding Can delay until 8.5 months following the year end Assumption Changes Amendments Reduce or freeze formula Recommend not using more than every 3-4 years

25 401(k)/Cash Balance Plans Maximum Total Contribution for Doctor Both Plans (Older NHCE s) PS CB Total Age Wages Deferrals Total Wages ,000 24,000 12, , , % 82.83% 57 30, , , % 8.50% 28 25, , , % 8.50% 65 32, , , % 8.50% 24 25, , , % 8.50% 56 40, , , % 8.50% 42 30, , , % 8.50% 182, ,740 2,730 15, % 447,000 24,000 24, , , %

26 Cash Balance & Profit Sharing Combination HCEs in Cash Balance/NHCEs in Profit Sharing PLAN PS CBP TOTAL PERCENT NAME AGE COMP CONT. CONT. ER CONT. OF TOTAL MD Husband , , , % MD Wife , , , % Employee ,000 3, , % Employee ,000 2, , % Employee ,000 2, , % HCE'S= $530,000 $0 $214,250 $214, % NHCE'S= $96,000 $9,456 $0 $9, % TOTAL= $626,000 $9,456 $214,250 $223, % Note: At least 40 non-excludable employees must be in Cash Balance Plan

27 SUMMARY OF TYPICAL COMBINATION PLANS DESIGN AND TESTING TESTING ANNUITY RATE CREDITING RATE AE ANNUITY RATE DC RATE CLASS A DC RATE CLASS B DC RATE CLASS C DC RATE CLASS D CBP RATE CLASS A CBP RATE CLASS B CBP RATE CLASS C CBP RATE CLASS D IRC 415 DOLLAR LIMIT COMP LIMIT Normal Retirement Age GAM(Male) 5.00% GAR (Blended) 13.14% 4.00% GATEWAY TEST: Highest HCE 43.00% 7.60% Lowest NHCE 7.52% 0.00% Result PASS 70.00% 25.00% CB 401(a)(26) TEST: 1.50% ACC RATE =.50% 45.00% 0.00% Result PASS RATE GROUP TEST: PASS ABPT TEST: PASS CONCENTRATION PCT 77.00% HCE AVG % SAFE HARBOR MID-POINT: 32.25% NHCE AVG 7.80% LOWEST RATIO: 38.46% ABPT 70.91% PLAN PERC OF NO. COMP CONT ER CONT HCE'S 3 795, , % NON-HCE'S , , % TOTAL 13 1,196, ,721 CONTRIBUTION LIMIT(31%) 299,122 IRC 404 Deductibility PASS

28 CONCLUSIONS With the possibility that because of the deficit and debt that Congress will curtail deductions for retirement plans in the future, it is important to take advantage of current opportunities to save Cash Balance Plans are the Cross-Tested Plans for the new millennium Somebody is going to talk to your clients about DB & CB Plans Shouldn t It Be YOU!!