Cash Balance Plans Maximizing Retirement Assets and Minimizing Your Tax Burden September 18, 2013 Presented by: Jason Casey, Senior Vice President Larry Butcher, EA, Actuary Principal
Agenda The Issue: American Taxpayer Relief Act of 2012 (ATRA) and Saving for Retirement A Solution: Cash Balance Plans Overview Case Studies Questions 2013 Verisight, Inc. www.verisightgroup.com 2
American Taxpayer Relief Act of 2012 (ATRA) What a Relief! The Facts Taxes are increasing in three different areas and are slightly different depending on your income threshold. Below is a general summary of tax increases by category at the highest income bracket: Tax Increase Categories: 1. Federal Income Tax (from 35.0% to 39.6%) 2. Medicare Tax (from 2.9% to 3.8%) 3. Capital Gains Tax (from 15% to 23.8%) 2013 Verisight, Inc. www.verisightgroup.com 3
Who is Most Impacted by the Passage of ATRA? High-earning individuals will see a significant increase in their 2013 tax liability: Small business owners Professional Services (Doctor s, lawyers, etc.) A hypothetical individual making $700,000 a year (including $150,000 in capital gains) will see their 2013 tax liability increase over $20,000 this year! 2013 Verisight, Inc. www.verisightgroup.com 4
Option One Pay Uncle Sam an additional $20,000 a year Option Two Invest $20,000 a year in a taxdeferred cash balance plan Result after 20 years: $0.00 Result after 20 years: $700,000.00* * Assuming a 5.5% annual rate of return 2013 Verisight, Inc. www.verisightgroup.com 5
Retirement Plan Contribution Limits* $212,100 $173,800 $51,000 $56,500 Profit Sharing 401(k) Cash Balance Cash Balance + 401(k) * 2013 plan maximum contributions for a 52 year-old including catch-up contributions. 2013 Verisight, Inc. www.verisightgroup.com 6
More Than Just a Tax Strategy Cash balance plans combined with a 401(k) or profit sharing plans offer the highest allowable contributions to a qualified plan. Individuals are able to save, on a tax deferred basis, in excess of $2,000,000+ in a matter of 5-10 years! 2013 Verisight, Inc. www.verisightgroup.com 7
Growth Rate of Cash Balance Plans Compared to 401(k) Plans Annual Growth Rate of Plan Implementations Cash Balance: 401(k): +21% -1% (Compared to 11% prior year) Source: public available 5500 data 2013 Verisight, Inc. www.verisightgroup.com 8
Top 5 States and Growth Trends Rank State % of National Total: Cash Balance Plans 1 CA 12% 2 NY 11% 3 OH 7% 4 IL 7% 5 NJ 7% Top 5 States Rank State (national total rank) % Annual Increase: Cash Balance Plans 1 FL (8) 34% 2 TX (6) 30% 3 MI (9) 26% Top Growth States 2013 Verisight, Inc. www.verisightgroup.com 9
Why are Cash Balance Plans Increasing in Popularity? 1. PPA Legislation Passed in 2006 Added clarity and simplified administration 2. Retirement Savings Crisis Average 401k balance in 2012: $77,300 ($133,100 for those ages 60-64) A 65-year old couple retiring today is estimated to need $240,000 just to pay for medical expenses in retirement 3. Tax Climate The American Taxpayer Relief Act of 2012 Federal income tax rates for the highest wage earners increased from 35% to 39.4% Higher Medicare tax (+0.9%) and Medicare surcharge (+3.8%) on capital gains for high wage earners Higher capital gains tax (increased from 15% to 20%) for highest wage earners and the additional 3.8% Medicare surcharge 2013 Verisight, Inc. www.verisightgroup.com 10
Who are Implementing Cash Balance Plans and Why? About 85% of current cash balance plans are with small businesses (<100 employees) Typical Occupations: Doctors Dentists Lawyers CPAs Consultants Financial Planners Contractors Real Estate Why so appealing? Fastest way to catch-up on retirement savings Ideal for small business owners who have sunk most of their assets into their business and are behind on their retirement savings plan Tax efficiency Significant tax savings that can far outweigh the increased compensation cost of staff Attraction and retention of key employees Asset protection ERISA protects all qualified plan assets from creditors in the event of bankruptcy or lawsuit 2013 Verisight, Inc. www.verisightgroup.com 11
A DC plan allocates contributions to accounts. Maximum Annual Contribution = $51,000 in 2013 for Participant at any age. A DB (Traditional) plan specifies benefits to be paid to participants. Estimated Annual Contribution required to fund maximum benefit at 65 for a participant age 55 is $127,500 (using 5.5% interest) Contributions are adjusted to reflect investment performance. DC Plan Model DB Plan Model Contribution Account Balance Benefit Contribution Account Balance Benefit Contribution Account Balance Contribution Benefit Contribution Account Balance Benefit Contribution Account Balance Benefit Individual Account Pooled Account Returns 2013 Verisight, Inc. www.verisightgroup.com 12
A Cash Balance Plan is a Defined Benefit Plan that looks like a Defined Contribution Plan A Cash Balance plan allocates Contributions/Pay Credits to hypothetical account balances (HAB). CB Plan Model Pay Credit Pay Credit Pay Credit Pay Credit Pay Credit Hypothetical Account Balance Hypothetical Account Balance Hypothetical Account Balance Hypothetical Account Balance Hypothetical Account Balance Pooled Account Returns 2013 Verisight, Inc. www.verisightgroup.com 13
Why is a Cash Balance Plan different? A Defined Benefit plan specifies benefits to be paid to participants. Maximum Annual Benefit Limit = $205,000 in 2013. This translates to a benefit amount at Normal Retirement Age of $17,083.33 per month payable for life. Contributions are adjusted to reflect investment performance, etc. Cash Balance Plans are a type of defined benefit plan Benefit Formulas for participants are expressed as a contribution amount equal to a percentage of pay or a flat dollar amount. Participants have virtual account balances instead of accrued benefits. Like accrued benefits of Defined Benefit Plans these account balances are guaranteed. Pay credits are generally based on current salary not average salary 2013 Verisight, Inc. www.verisightgroup.com 14
Cash Balance Plans What you see is what you get. Benefit Formula Employer contribution = 5% of pay per year. A salary of $100,000 *.05 gets you a $5,000 contribution Interest crediting rate (defined in plan document) is applied to BOY account balances All assets for the plan are invested in one trust expressed as hypothetical account balances for each participant. Plan sponsor essentially guarantees the participant account balances Investment risk is borne by the plan sponsor 2013 Verisight, Inc. www.verisightgroup.com 15
The Participant sees a benefit that means something A defined benefit plan statement. XYZ Defined Benefit Plan Personal Statement for Participant G As of 12/31/2013 Your Estimated Monthly Benefit at Normal Retirement Date From Your Pension Plan $17,083.33* Your Accrued Benefit Your Current Monthly Accrued Benefit $4,625.00* *Benefits are payable starting at your normal retirement date for the balance of your life. A cash balance plan statement. XYZ Cash Balance Plan Participant G As of 12/31/2013 Account Balance 01/01/2013 $335,412.80 Additions Plan Contributions $164,000.00 Investment Earnings $15,160.66 Account Balance 12/31/2013 $514,573.46 2013 Verisight, Inc. www.verisightgroup.com 16
When does a Cash Balance Plan make sense? Any size company or partnership such as a law firm or medical practice Desire to equalize benefits and contributions for partners Staff / Partner ratio is small Target employees are generally older than staff Partners/owners are already contributing up to the profit sharing / 401(k) limit and want to contribute more. 2013 Verisight, Inc. www.verisightgroup.com 17
Estimated first year maximum cash balance credits for 2013 Age NRA 65 NRA 62 Age NRA 65 NRA 62 64 $226,000 $ 50 $114,000 $141,500 63 $215,200 $ 49 $108,600 $134,700 62 $205,000 $ 48 $103,500 $128,300 61 $195,200 $242,100 47 $98,600 $122,200 60 $185,900 $230,500 46 $93,800 $116,400 59 $177,100 $219,500 45 $89,300 $110,900 58 $168,600 $209,100 44 $85,100 $105,500 57 $160,600 $199,100 43 $81,000 $100,500 56 $152,900 $189,600 42 $77,100 $95,700 55 $145,600 $180,600 41 $73,500 $91,220 54 $138,700 $171,900 40 $70,000 $86,800 53 $132,100 $163,700 39 $66,700 $82,700 52 $125,800 $156,000 38 $63,500 $78,800 51 $119,900 $148,600 37 $60,400 $75,000 2013 Verisight, Inc. www.verisightgroup.com 18
DB/DC combo small physician group ABC Radiologists 30 employees and is consistently profitable Two main classes - Owners and Staff 3 Owners and 27 employees Owners want to increase own retirement plan contribution while controlling costs to staff 2013 Verisight, Inc. www.verisightgroup.com 19
DB/DC combo small physician group Employees Traditional profit sharing plan % of pay Traditional profit sharing plan with 401(k)² % of pay¹ Class-based profit sharing plan and 401(k) % of pay¹ Dr. Adams $51,000 20% $56,500 20% $56,500 20.0% Dr. Baker $51,000 20% $56,500 20% $56,500 20.0% Dr. Cox $51,000 20% $51,000 20% $51,000 20.0% Doctor total $153,000 $164,000 $164,000 Staff $165,400 20% $109,704 13.20% $41,350 5% Total $318,400 $273,704 $205,350 ¹Excludes catch-up contributions ²Assumes safe harbor 401(k) with QNEC of 3% and profit sharing contribution of 10.14% 2013 Verisight, Inc. www.verisightgroup.com 20
DB/DC combo small physician group Reduction in profit sharing costs through plan design Employees Traditional profit sharing plan % of pay Traditional profit sharing plan with 401(k)² % of pay¹ Class-based profit sharing plan and 401(k) % of pay¹ Dr. Adams $51,000 20% $56,500 20% $56,500 20.0% Dr. Baker $51,000 20% $56,500 20% $56,500 20.0% Dr. Cox $51,000 20% $51,000 20% $51,000 20.0% Doctor total $153,000 $164,000 $164,000 Staff $165,400 20% $109,704 13.14% $41,350 5% Total $318,400 $273,704 $205,350 ¹Excludes catch-up contributions ²Assumes safe harbor 401(k) with QNEC of 3% and profit sharing contribution of 10.14% 2013 Verisight, Inc. www.verisightgroup.com 21
DB/DC combo small physician group Reduction in profit sharing costs through plan design Employees Traditional profit sharing plan % of pay Traditional profit sharing plan with 401(k)² % of pay¹ Class-based profit sharing plan and 401(k) % of pay¹ Dr. Adams $51,000 20% $56,500 20% $56,500 20.0% Dr. Baker $51,000 20% $56,500 20% $56,500 20.0% Dr. Cox $51,000 20% $51,000 20% $51,000 20.0% Doctor total $153,000 $164,000 $164,000 Staff $165,400 20% $109,704 13.20% $41,350 5% Total $318,400 $273,704 $205,350 ¹Excludes catch-up contributions ²Assumes safe harbor 401(k) with QNEC of 3% and profit sharing contribution of 10.14% 2013 Verisight, Inc. www.verisightgroup.com 22
DB/DC combo small physician group Reduction in profit sharing costs through plan design Employees Traditional profit sharing plan % of pay Traditional profit sharing plan with 401(k) % of pay¹ DB/DC Combo Plan³ % of pay¹ Dr. Adams $51,000 20% $56,500 20% $233,760 95.4% Dr. Baker $51,000 20% $56,500 20% $198,760 81.1% Dr. Cox $51,000 20% $51,000 20% $124,760 50.9% Doctor total $153,000 $164,000 $557,280 Staff $165,400 20% $109,704 13.14% $82,700 10% Total $318,400 $273,704 $639,980 1 Excludes catch up contributions 2 Assumes safe harbor 401(k) with QNEC of 3% and profit sharing contribution of 10.14% 3 Cash Balance Plan with Benefits Payable at 62 and Safe Harbor 401(k) with a Cross Tested Profit Sharing Plan 2013 Verisight, Inc. www.verisightgroup.com 23
DB/DC combo large law firm XYZ Attorneys and Assoc. More than 350 lives and consistently profitable 10 shareholders and 43 partners Four main classes Shareholders Partners Attorneys Staff Shareholders want to increase own retirement plan contributions while controlling costs to staff 2013 Verisight, Inc. www.verisightgroup.com 24
DB/DC combo large law firm Separate employees into three different classes Shareholders: $40,000 Cash Balance contribution $51,000 13.14% Profit Sharing and 401(k) contributions $91,000 Annual contributions Partners: $1,000 Cash Balance contribution $51,000 13.14% Profit Sharing and 401(k) contributions $52,000 Annual contributions Attorneys & Staff: $0 Cash Balance contribution 5.75% Profit Sharing contribution 401(k) contributions also available 2013 Verisight, Inc. www.verisightgroup.com 25
DB/DC combo large law firm Overall contribution and tax savings results 2013 Verisight, Inc. www.verisightgroup.com 26
DB/DC combo small entrepreneur AAA Widget Makers 4 employees and consistently profitable 1 Owner, 1 Executive and 2 Staff Three main classes Owner, Executive, & Staff Owner wants to increase retirement plan contributions and keep important non-owner executive benefits, while controlling overall costs 2013 Verisight, Inc. www.verisightgroup.com 27
DB/DC combo small entrepreneur Separate employees into three different classes Owner: $183,800 Cash Balance contribution $ 56,500 Profit Sharing and 401(k) contributions $240,300 Annual contributions Non-Owner: $90,024 Cash Balance contribution $38,840 Profit Sharing and 401(k) contributions Staff: $1,800 Cash Balance contribution $4,080 Profit Sharing contribution 401(k) contributions also available 2013 Verisight, Inc. www.verisightgroup.com 28
DB/DC combo small entrepreneur Cash Profit Total Name Age Salary Balance Sharing 401(k) Contribution Owner* 57 255,000 183,800 33,500 23,000 240,300 Executive* 59 120,000 90,024 15,840 23,000 128,864 Employee 27 60,000 1,800 4,080 0 5,880 Employee 25 60,000 1,800 4,080 0 5,880 Total Target Employees 375,000 273,824 49,340 46,000 369,164 Total Others 120,000 3,600 8,160 0 11,760 Total 495,000 277,424 57,500 46,000 380,924 Portion to Target employees 76% 98.7% 85.8% 100.0% 96.9% Total Qualified Retirement Plan Contributions 380,924 Estimated tax rate 35% Tax Savings on Company Contributions 133,323 Total Others - Contributions for Staff 11,760 Net (Cost)/Benefit of Proposed Plan Design 121,563 2013 Verisight, Inc. www.verisightgroup.com 29
Cash Balance Plan Design Considerations We can reduce number of participants in Cash Balance Plan by classification (owners, nurses, administrative staff, CEO etc.) Must meet minimum coverage under Code Section-lesser of 40% of eligible staff or 50 participants Must provide meaningful benefits Eligibility-age 21 and 1 year of service Normal Retirement Age- later of age 62 and 5 years of participation in Plan Provide for in service distribution at age 62 3 year cliff vesting schedule-new plans can exclude past service for vesting (everyone starts at 0%) 5% interest crediting rate on hypothetical contributions Hypothetical contributions can be flat dollar amount ($5,000) or Percentage of Compensation 1000 hours needed to receive hypothetical contribution No loans-use 401k for this option 2013 Verisight, Inc. www.verisightgroup.com 30
Question 1 What is a DB plan? 2 What is the difference between a DB plan and a Cash Balance DB plan? 3 Can hypothetical contributions be changed each year? 4 5 6 7 Can a plan sponsor stop contributing to a DB if financial conditions change at the firm? What options do they have? How long does a DB plan need to be in existence before it can be terminated? Can participants control their own investments in a DB plan? Or how are investments handled in a DB plan? Are there any types of investments that are NOT allowed in a DB plan? 8 Are there other investment considerations. 9 What rate do the DB plan assets need to achieve to remain fully (well) funded? Is that rate listed in the document? Can that be changed how often? Answer A plan that is sponsored by the employer with the promise to provide a monthly benefit to plan participants either as a percentage of compensation or a stated dollar amount upon reaching normal retirement age as defined in the plan document. Nothing other than the presentation of the plan. A traditional defined benefit plan shows monthly benefits and the costs associated to provide the benefit. Whereas, a cash balance plan illustrates hypothetical contributions and interest credits that are allocated to an account (beginning balance, contribution, interest ending balance); both plans are subject to minimum funding requirements. Hypothetical contributions could change each year if the formula to determine these hypothetical contributions is pay related in terms of a % of compensation. The percentage doesn t change only the amount of the hypothetical contribution. Otherwise, the hypothetical contributions cannot change each year. Generally no, you could possibly reduce the amount of contributions by taking steps to freeze benefit accruals. However, you must complete all steps necessary to freeze the plan before the participants accrue benefits for the plan year. There are Notices that must be given prior to freezing the Plan. The timelines for the advance Notice depends on the number of participants in the Plan. A condition for establishing any qualified plan is that the employer intends for it to be permanent. There is no set time limit for how long the plan must stay in place. Generally, the IRS is unlikely to challenge a plan s permanency if a qualified plan has been in existence more than 10 years. A challenge may occur when a qualified plan is in existence less than 10 years. It is important to note that when there are valid business issues for terminating the plan such as a change in ownership of the employer, the liquidation or dissolution of the employer; adverse business conditions; or the adoption of new plan are all permissible reasons to terminate a retirement plan. No. Investments in a defined benefit plan are in a pooled account that is trustee directed. Investments that are not traded on the open market are permitted but present a problem in that according to the Code, the plan assets for determining the funding requirements must have a fair market value. Yes. A plan must be careful avoid entering into a prohibited transaction with a party-in-interest to the plan. For example, awarding the plan s investment contract to a board member might be a prohibited transaction. This can be a facts and circumstances analysis that may require legal advice. The actuarially assumed investment return for Defined Benefit plans tends to range from 5% to 8%. The rate is not listed in the Plan document. The actuary has limited discretion under IRS guidelines with respect to determining the interest rate assumption. 2013 Verisight, Inc. www.verisightgroup.com 31
Thank you for your time! Questions? Contact us: Info@verisightgroup.com 855-751-2127 2013 Verisight, Inc. www.verisightgroup.com 32