Is It Time To Add A Defined Benefit Plan?

Transcription

1 Is It Time To Add A Defined Benefit Plan? Lorraine Dorsa, FCA, MAAA, MSPA, EA, CEBS Aegis Pension Services, Inc. Your plan sponsor wants more... When is the right time to add a defined benefit or cash balance plan? This workshop will provide insight to identifying prospects and ensuring a smooth implementation. Attendees will learn: How to identify if your client is a candidate How to identify key communication points that the plan sponsor must understand What coordination with the DC plan is necessary 2 1

2 Lorraine Dorsa is an Enrolled Actuary and Certified Employee Benefits Specialist, a Fellow of the Conference of Consulting Actuaries and Member of the American Academy of Actuaries and the American Society of Pension Professionals and Actuaries (ASPPA). She has extensive experience providing defined benefit and cash balance plan design, consulting and actuarial support services to DC plan administrators, TPAs and financial institutions. Lorraine is a principal at Aegis Pension Services and a frequent speaker at employee benefits conferences including those sponsored by ASPPA, AICPA and other professional associations as well as seminars sponsored by financial institutions, plan sponsors and other groups. 3 Comments The category of defined benefit can be thought of as having two sub-types: Traditional Defined Benefit (DB) Cash Balance (CB) This presentation addresses both DB & CB plans as the considerations re establishing these plans are very much the same. 4 2

3 DB Thumbnail Sketch Looks at benefit to be paid out, not contributions put in Benefit formula is stated in the plan, generally a function of compensation & svc No annual 415 limits on contributions credited to a participant (415 limit applies to amount that is ultimately paid out considering years of service/participation) Benefits defined as monthly benefit payable upon retirement (generally participant can elect distribution in the form a lump sum) Employer contributions are required, not discretionary Actuarial valuation & certifications required Additional rules not applicable to DC plans (funding requirements, minimum participation rule, PBGC coverage, etc) 5 DB Example Name Current Age Retirement Age Defined Benefit Monthly Benefit at Retirement Defined Benefit Contribution (Recommended) 401k Salary Deferral Profit Sharing Contribution Owner , ,000 18,500 6, ,500 Total Benefit formula: 8% of average monthly compensation multiplied by years of service, 1 past year Compensation: $100,000 per year 6 3

4 CB Thumbnail Sketch Really is a DB plan it just looks like a DC plan Same rules as DB plan (see prior slide) Benefits defined in terms of a hypothetical account balance (not based on assets) Benefit formula is stated in the plan interest credits flat rate or by reference to index (most commonly) Employer credits % of pay or flat $; often different formula for different groups BOY + interest credit + employer credit = EOY 7 CB Example Total Contribution Cash Balance 401(k) Safe Profit Sharing Employer % of Class AA RA Compensation Amount % Deferral Harbor Amount % Amount % Cost % Total A DOCTOR OWNER , , ,500 7, , , N OFFICE MANAGER , ,080 1, , , O MEDICAL ASSISTANT , , , OWNER 250, , ,500 7, , , STAFF 58, ,740 2, , , , , ,500 9,240 2, , ,

5 Business Types Owner Dominated / Closely Held / Small Business heavily reliant on owner s presence & activity Goal is to provide compensation to owners Plan design focuses on benefiting owners Safe Harbor 401k Cross-Tested Profit Sharing Defined Benefit/Cash Balance 9 Business Types Employee Dominated / Corporate / Large Business activity is primarily conducted by employees; owners may or may not be involved in day to day operations Business income is generated by the use of capital assets and actions performed by employees Plan design focuses on appropriate (and often across the board) compensation & benefits for employees Usually 401k, often with Match and perhaps Profit Sharing (likely same formula for all) Less frequently Defined Benefit/Cash Balance (likely flat rate formula, maybe service component) 10 5

6 Life Stage of Business True Startup No existing client base or profit history No compensation history Not likely candidate for DB (at least not immediately) Candidate for plan with flexibility / least commitment SIMPLE 401(k) with match & discretionary PS; maybe SH 11 Life Stage of Business Re-Startup Existing client base & history of profit from client base No compensation history with the firm Candidate for similar plan as true startup Could be candidate for DB plan Professional services firm High income/cash flow business Had DB in prior firm Restart has less employees (maybe only owner) than prior business 2 nd career for principal after corporate career 12 6

7 Life Stage of Business Continuing Business Existing client base Compensation & profit history Ability to budget/forecast financials/cash flow Appropriate plan type depends on business situation, owner goals, HR needs, financial situation of the business All plan types 13 Life Stage of Business Restructure / Wind-Up Most factors the same as continuing business Looking at reconfiguration event, maybe in short term or planning for one in the next 5 10 years Short term events are likely sale of the business, merger/acquisition, etc Longer term events might be planning for retirement/exit of principal(s), facilitating buy in by new owner(s) Existing plan designs may need to be modified to accommodate Retirement/exit of principals may be facilitated by DB/CB 14 7

8 Business Objectives Impacting Plan Selection Attract/retain all employees (employee benefit) Attract/retain special groups of employees Provide additional $ to favored group of employees Tax deductions for the business Compensate owner(s)/principal(s) in a tax-favored way Build retirement savings for owner(s)/principal(s) so they can timely exit the business and make room for new owner(s)/principal(s) 15 Business Concerns Impacting Plan Selection Cost Employee appreciation of plan Level of commitment to plan Flexibility/timing re employer contributions Required employer contributions vs. discretionary Long term commitment to maintain plan Ability to direct contributions to favored employees 16 8

9 Business Objectives & DB/CB MAYBE Attract/retain all employees MAYBE Attract/retain special groups of employees YES Provide additional $ to favored group of employees YES Tax deductions for the business YES Compensate owner(s)/principal(s) in a tax-favored way YES Build retirement savings for owner(s)/principal(s) so they can timely exit the business and make room for new owner(s)/principal(s) 17 Business Concerns & DB/CB HIGH Cost MAYBE Employee understanding/appreciation of plan HIGH Level of commitment to plan SOME Flexibility/timing re employer contributions REQUIRED Required employer contributions vs. discretionary YES Long term commitment to maintain plan YES Ability to direct contributions to favored employees 18 9

10 Likely DB/CB Prospects Professionals such as doctors, dentists, attorneys Family businesses Businesses with high cash flow / retained earnings Multi-partner practices with partners with different goals / needs Closely held businesses with age 45+ owner(s) Consultants Baby boomers Mine your client base! 19 DB/CB Opportunities Profitable business with predictable profits & cash flow looking for options Interest in minimizing taxes Tax on current business income Tax on current owner compensation Tax deferred growth of retirement savings Interest often peaks right after prior year taxes are paid and during tax planning season Business owner doing financial planning for himself personally 20 10

11 DB/CB Opportunity Events Business planning re succession/retirement Addition of new partners Aging business owners looking for an exit strategy Restart-ups Remaining business after an asset sale I want a cash balance plan like my brother-in-law has Baby boomers 21 Goal: Design: $ k/year for 1 man business $100k DB + optional deferrals & PS Name Current Age Retirement Age Defined Benefit Monthly Benefit at Retirement Defined Benefit Contribution (Recommended) 401k Salary Deferral Profit Sharing Contribution Owner , ,000 18,500 6, ,500 Total Benefit formula: 8% of average monthly compensation multiplied by years of service, 1 past year Compensation: $100,000 per year [DB exempt from PBGC so PS limited to 6%] 22 11

12 Goal: Design: Maximum (with low compensations) DB with past service + deferrals & PS Name Current Age Retirement Age Defined Benefit Monthly Benefit at Retirement Defined Benefit Contribution (Recommended) 401k Salary Deferral Profit Sharing Contribution Husband , ,000 24,500 5, ,900 Wife ,917 92,000 24,500 3, ,500 Total 225,000 49,000 8, ,400 Benefit formula: 10% of average monthly compensation multiplied by years of service, 1 past year Compensation: $90,000 per year for husband, $50,000 per year for wife [DB exempt from PBGC so PS limited to 6%] 23 Goal: Design: ~$600k budget for H&W business $100k DB + optional deferrals & PS Name Current Age Retirement Age Defined Benefit Monthly Benefit at Retirement Defined Benefit Contribution (recommended) 401k Salary Deferral (optional) Profit Sharing Contribution (optional) Total Husband , ,000 24, ,500 Wife ,333 78,000 24, , ,000 49, ,000 Benefit formula: 10% of average monthly compensation multiplied by years of service, 2 past years Compensation: initial year $215,000 husband $100,000 wife next 2 years $222,500 $100,000 after 3 yr average established, only relevant for DC plan Budget: Year 1 Years 2&3 DB recommended $269,000 $272,000 Compensation 315, ,500 $584,000 $594,500 Optional PS (limited to 6%) $ 18,900 $ 19,

13 Goal: $150k for doctor [small medical practice] Current plan is 401k/PS with 3% SH Staff is much younger Wants to layer CB on top of current 401k/PS Can do so, but must limit SH+PS to 6% of aggregate compensation [combined deduction limits of IRC 404a7 apply because CB is exempt from PBGC] Non-discrimination testing required 25 Design: CB + deferrals + SH + PS [small medical practice] Total Contribution Cash Balance 401(k) Safe Profit Sharing Employer % of Class AA RA Compensation Amount % Deferral Harbor Amount % Amount % Cost % Total A DOCTOR OWNER , , ,500 7, , , N OFFICE MANAGER , ,080 1, , , O MEDICAL ASSISTANT , , , OWNER 250, , ,500 7, , , STAFF 58, ,740 2, , , , , ,500 9,240 2, , ,

14 Goal: Max Owner as possible Staff = Mtch + Gateway/401a26 [property mgmt company] Current plan is 401k/PS with matching SH Staff ages mixed Wants to give staff SH match + gateway/401a26 If need to give more to staff, choose administration staff CB is PBGC covered - IRC 404a7 limit not applicable Non-discrimination testing required 27 Design: Max 401k/PS to Owner CB + SH Match + PS [property management company] Total Contribution Cash Balance 401(k) 401(m) Profit Sharing Employer % of Class AA RA Compensation Amount % Deferral Match Amount % Amount % Cost % Total A OWNER , , ,500 11,000 25, , , N ADMINISTRATION STAFF ,170 1, ,607 1,406 2, , , N ADMINISTRATION STAFF ,072 1, ,283 1,998 3, , , N ADMINISTRATION STAFF , ,300 1,137 2, , , N ADMINISTRATON STAFF ,611 1, ,024 2,646 5, , , N ADMINISTRATON STAFF ,917 1, ,117 1,852 3, , , O MAINTENANCE STAFF , ,587 2,264 4, , , O MAINTENANCE STAFF , ,689 1,478 3, , , O MAINTENANCE STAFF , , , , OWNER STAFF 275, , ,500 11,000 25, , , ,527 6, ,607 12,781 28, , , , , ,107 23,781 54, , ,

15 Goal: Level $ to Partners Staff Cost < 10% of pay [multiple partner medical practice] No current plan Partners = different ages Limited SH to NHCEs only for flexibility re testing Must limit SH+PS to 6% of aggregate compensation [combined deduction limits of IRC 404a7 apply because CB is exempt from PBGC] Non-discrimination testing is required 29 Design: CB + deferrals + SH + PS [multiple partner medical practice] Total Contribution Cash Balance 401(k) Safe Profit Sharing Employer % of Class AA RA Compensation Amount % Deferral Harbor Amount % Amount % Cost % Total A PARTNER , , , , , , A PARTNER , , , , , , A PARTNER , , , , , , M MANAGER OFFICE , ,920 1,920 2, , , N MEDICAL STAFF , ,066 1,598 2, , , N MEDICAL STAFF , ,612 1,567 2, , , O OFFICE STAFF , , , , O OFFICE STAFF , , , , O OFFICE STAFF , , , , O OFFICE STAFF , , , , PARTNERS STAFF 825, , , , , , ,620 2, ,604 8,689 14, , , ,114, , ,104 8,689 38, , ,

16 Goal: Max to Father Minimum Staff Cost [family retail business] No current plan Father + 2 children Father wants $ to retire, Son willing to direct company $ to him so he can retire No safe harbor [high turnover & does not want to vest] CB is PBGC covered - IRC 404a7 limit not applicable Non-discrimination testing is required 31 Design: CB + deferrals + SH + PS [family retail business] Total Contribution Cash Balance Profit Sharing Employer % of Class AA RA Compsensation Amount % Amount % Amount % Cost % Total A OWNER , , , , , B DAUGHTER ,512 1, , , , B SON ,176 5, , , , M MANAGER ,950 2, , , , N SALES , , , , N SALES , , , , N SALES , , , , N SALES , , , , N SALES , , , , N SALES , , , , O STOCKROOM , , , , O STOCKROOM , , , O STOCKROOM , , , O STOCKROOM , , , FAMILY STAFF 492, , , , , ,832 3, , , , , , , , ,

17 Goal: Individually Max Partners [2 partner practice] Current plan = 401k/PS with 3% SH Partners = different ages Staff varying ages but relatively young Must limit SH+PS to 6% of aggregate compensation [combined deduction limits of IRC 404a7 apply because CB is exempt from PBGC] Non-discrimination testing is required 33 Design: CB + deferrals + SH + PS [2 partner practice] Total Contribution Cash Balance 401(k) Safe Profit Sharing Employer % of Class AA RA Compensation Amount % Deferral Harbor Amount % Amount % Cost % Total A PARTNER , , ,500 6,900 8, , , B PARTNER , , ,500 6,900 8, , , C ATTORNEY ASSOCIATE , , , , C ATTORNEY ASSOCIATE , , , , N LEGAL STAFF , ,173 3, , , N LEGAL STAFF , ,000 4, , , N LEGAL STAFF , ,495 3, , , O SUPPORT STAFF , ,064 1, , , O SUPPORT STAFF , ,200 1, , , O SUPPORT STAFF , , , , O SUPPORT STAFF , , , , O SUPPORT STAFF , ,111 1, , , PARTNERS ASSOCIATES & STAFF 460, , ,000 13,800 16, , , ,103 3, ,003 18, , , ,260, , ,000 37,803 34, , ,

18 Questions? 18