Is It Time To Add A Defined Benefit Plan?

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

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

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 46 62 8,333 100,000 18,500 6,000 124,500 Total Benefit formula: 8% of average monthly compensation multiplied by years of service, 1 past year Compensation: $100,000 per year 6 3

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 53 62 250,000 117,500 47.0 24,500 7,500 500 0.2 150,000 60.0 125,500 50.2 96.6 N OFFICE MANAGER 27 62 36,000 0 0.0 0 1,080 1,440 4.0 2,520 7.0 2,520 7.0 1.9 O MEDICAL ASSISTANT 20 62 22,000 440 2.0 0 660 814 3.7 1,914 8.7 1,914 8.7 1.5 OWNER 250,000 117,500 47.0 24,500 7,500 500 0.2 150,000 60.0 125,500 50.2 96.6 STAFF 58,000 440 0.8 0 1,740 2,254 3.9 4,434 7.6 4,434 7.6 3.4 308,000 117,940 38.3 24,500 9,240 2,754 0.9 154,434 50.1 129,934 42.2 100.0 8 4

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

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

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

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

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

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

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: $100-125k/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 46 62 8,333 100,000 18,500 6,000 124,500 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

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 60 65 5,250 133,000 24,500 5,400 162,900 Wife 60 65 2,917 92,000 24,500 3,000 119,500 Total 225,000 49,000 8,400 282,400 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 54 62 14,333 191,000 24,500 0 215,500 Wife 52 62 8,333 78,000 24,500 0 102,500 269,000 49,000 0 318,000 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 315,000 322,500 $584,000 $594,500 Optional PS (limited to 6%) $ 18,900 $ 19,350 24 12

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 53 62 250,000 117,500 47.0 24,500 7,500 500 0.2 150,000 60.0 125,500 50.2 96.6 N OFFICE MANAGER 27 62 36,000 0 0.0 0 1,080 1,440 4.0 2,520 7.0 2,520 7.0 1.9 O MEDICAL ASSISTANT 20 62 22,000 440 2.0 0 660 814 3.7 1,914 8.7 1,914 8.7 1.5 OWNER 250,000 117,500 47.0 24,500 7,500 500 0.2 150,000 60.0 125,500 50.2 96.6 STAFF 58,000 440 0.8 0 1,740 2,254 3.9 4,434 7.6 4,434 7.6 3.4 308,000 117,940 38.3 24,500 9,240 2,754 0.9 154,434 50.1 129,934 42.2 100.0 26 13

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 56 62 275,000 126,500 46.0 24,500 11,000 25,500 9.3 187,500 68.2 163,000 59.3 77.2 N ADMINISTRATION STAFF 41 62 40,170 1,004 2.5 1,607 1,406 2,812 7.0 6,829 17.0 5,222 13.0 2.5 N ADMINISTRATION STAFF 36 62 57,072 1,427 2.5 2,283 1,998 3,995 7.0 9,702 17.0 7,419 13.0 3.5 N ADMINISTRATION STAFF 28 62 32,498 812 2.5 1,300 1,137 2,275 7.0 5,525 17.0 4,225 13.0 2.0 N ADMINISTRATON STAFF 51 62 75,611 1,890 2.5 3,024 2,646 5,293 7.0 12,854 17.0 9,829 13.0 4.7 N ADMINISTRATON STAFF 64 64 52,917 1,323 2.5 2,117 1,852 3,704 7.0 8,996 17.0 6,879 13.0 3.3 O MAINTENANCE STAFF 56 62 64,686 0 0.0 2,587 2,264 4,851 7.5 9,703 15.0 7,115 11.0 3.4 O MAINTENANCE STAFF 58 62 42,229 0 0.0 1,689 1,478 3,167 7.5 6,334 15.0 4,645 11.0 2.2 O MAINTENANCE STAFF 48 62 37,344 0 0.0 0 0 2,801 7.5 2,801 7.5 2,801 7.5 1.3 OWNER STAFF 275,000 126,500 46.0 24,500 11,000 25,500 9.3 187,500 68.2 163,000 59.3 77.2 402,527 6,457 1.6 14,607 12,781 28,898 7.2 62,744 15.6 48,136 12.0 22.8 677,527 132,957 19.6 39,107 23,781 54,398 8.0 250,244 36.9 211,136 31.2 100.0 28 14

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 1 56 65 275,000 137,500 50.0 24,500 0 8,250 3.0 170,250 61.9 145,750 53.0 31.5 A PARTNER 2 53 65 275,000 137,500 50.0 24,500 0 8,250 3.0 170,250 61.9 145,750 53.0 31.5 A PARTNER 3 60 65 275,000 137,500 50.0 24,500 0 8,250 3.0 170,250 61.9 145,750 53.0 31.5 M MANAGER OFFICE 38 65 64,000 0 0.0 1,920 1,920 2,880 4.5 6,720 10.5 4,800 7.5 1.0 N MEDICAL STAFF 56 65 53,281 0 0.0 1,066 1,598 2,398 4.5 5,062 9.5 3,996 7.5 0.9 N MEDICAL STAFF 42 65 52,241 0 0.0 2,612 1,567 2,351 4.5 6,530 12.5 3,918 7.5 0.8 O OFFICE STAFF 51 65 30,681 614 2.0 614 920 1,687 5.5 3,835 12.5 3,222 10.5 0.7 O OFFICE STAFF 38 65 30,319 606 2.0 910 910 1,668 5.5 4,093 13.5 3,183 10.5 0.7 O OFFICE STAFF 53 65 30,119 602 2.0 904 904 1,657 5.5 4,066 13.5 3,162 10.5 0.7 O OFFICE STAFF 36 65 28,979 580 2.0 580 869 1,594 5.5 3,622 12.5 3,043 10.5 0.7 PARTNERS STAFF 825,000 412,500 50.0 73,500 0 24,750 3.0 510,750 61.9 437,250 53.0 94.5 289,620 2,402 0.8 8,604 8,689 14,234 4.9 33,928 11.7 25,324 8.7 5.5 1,114,620 414,902 37.2 82,104 8,689 38,984 3.5 544,678 48.9 462,574 41.5 100.0 30 15

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 61 65 275,000 264,000 96.0 55,000 20.0 319,000 116.0 319,000 116.0 87.4 B DAUGHTER 40 65 46,512 1,395 3.0 1,395 3.0 2,791 6.0 2,791 6.0 0.8 B SON 38 65 171,176 5,135 3.0 5,135 3.0 10,271 6.0 10,271 6.0 2.8 M MANAGER 76 80 78,950 2,369 3.0 5,132 6.5 7,500 9.5 7,500 9.5 2.1 N SALES 47 65 52,723 0 0.0 3,954 7.5 3,954 7.5 3,954 7.5 1.1 N SALES 47 65 48,702 0 0.0 3,653 7.5 3,653 7.5 3,653 7.5 1.0 N SALES 26 65 32,888 0 0.0 2,467 7.5 2,467 7.5 2,467 7.5 0.7 N SALES 43 65 50,245 0 0.0 3,768 7.5 3,768 7.5 3,768 7.5 1.0 N SALES 76 80 51,938 0 0.0 3,895 7.5 3,895 7.5 3,895 7.5 1.1 N SALES 64 68 33,467 0 0.0 2,510 7.5 2,510 7.5 2,510 7.5 0.7 O STOCKROOM 53 65 19,515 390 2.0 1,268 6.5 1,659 8.5 1,659 8.5 0.5 O STOCKROOM 23 65 13,315 266 2.0 865 6.5 1,132 8.5 1,132 8.5 0.3 O STOCKROOM 55 65 13,928 279 2.0 905 6.5 1,184 8.5 1,184 8.5 0.3 O STOCKROOM 29 65 13,161 263 2.0 855 6.5 1,119 8.5 1,119 8.5 0.3 FAMILY STAFF 492,688 270,531 54.9 61,531 12.5 332,061 67.4 332,061 67.4 91.0 408,832 3,567 0.9 29,274 7.2 32,841 8.0 32,841 8.0 9.0 901,520 274,098 30.4 90,804 10.1 364,902 40.5 364,902 40.5 100.0 32 16

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 1 58 62 230,000 218,500 95.0 24,500 6,900 8,050 3.5 257,950 111.9 233,450 101.5 50.3 B PARTNER 2 53 62 230,000 170,200 74.0 24,500 6,900 8,050 3.5 209,650 90.9 185,150 80.5 39.9 C ATTORNEY ASSOCIATE 41 62 236,303 0 0.0 0 7,089 0 0.0 7,089 3.0 7,089 3.0 1.5 C ATTORNEY ASSOCIATE 37 62 134,875 0 0.0 0 4,046 0 0.0 4,046 3.0 4,046 3.0 0.9 N LEGAL STAFF 54 62 72,423 0 0.0 0 2,173 3,259 4.5 5,432 7.5 5,432 7.5 1.2 N LEGAL STAFF 31 62 100,000 0 0.0 0 3,000 4,500 4.5 7,500 7.5 7,500 7.5 1.6 N LEGAL STAFF 39 62 83,180 0 0.0 0 2,495 3,743 4.5 6,239 7.5 6,239 7.5 1.3 O SUPPORT STAFF 63 67 35,472 709 2.0 0 1,064 1,419 4.0 3,192 9.0 3,192 9.0 0.7 O SUPPORT STAFF 37 62 40,015 800 2.0 0 1,200 1,601 4.0 3,601 9.0 3,601 9.0 0.8 O SUPPORT STAFF 28 62 33,023 660 2.0 0 991 1,321 4.0 2,972 9.0 2,972 9.0 0.6 O SUPPORT STAFF 25 62 27,775 556 2.0 0 833 1,111 4.0 2,500 9.0 2,500 9.0 0.5 O SUPPORT STAFF 52 62 37,037 741 2.0 0 1,111 1,481 4.0 3,333 9.0 3,333 9.0 0.7 PARTNERS ASSOCIATES & STAFF 460,000 388,700 84.5 49,000 13,800 16,100 3.5 467,600 101.4 418,600 91.0 90.1 800,103 3,466 0.4 0 24,003 18,435 2.3 45,905 5.7 45,905 5.7 9.9 1,260,103 392,166 31.1 49,000 37,803 34,535 2.7 513,505 40.7 464,505 36.9 100.0 34 17

Questions? 18