strategic retirement plan designs for professional practices 92011

For Internal Use Only: Not for Public Distribution

Strategic Retirement Plan Designs for High Income Professionals

A discussion of how to generate high tax deductions and accelerated retirement savings though qualified plan options.

© 2011 | ExpertPlan | Retirement Plan Services 1


A retirement dilemma to consider

• Many business owners are NOT putting away sufficient tax-deferred dollars into a qualified retirement plan so they can retire in a timely manner and live comfortable after active work.

• The reasons are generally two fold:

• Some, just don’t have the income to support funding a retirement plan.

• Many however do have the income and still do not fund the “maximum” amount of money they can to build a tax-deferred retirement savings base.

2© 2011 | ExpertPlan | Retirement Plan Services


• There are two main reasons business owners do not allocate more dollars to tax-deferred qualified plans:

• 1) Some believe they are already putting the “maximum” away.

• 2) Many believe that in order to put significantly more money away it will be cost prohibitive because of sizable contributions for employees

• With proper plan design, it may be possible to “increase” your maximum while minimizing or significantly reducing your employee contribution obligations!



The Basics - Defined Contribution Plans


Defined Contribution (DC) Plans: permits employee

contributions to be deducted, employee contributions are

always 100% vested whereby employers contributions more

often have vesting schedules which are stated under the terms

of the plan (this plan is also referred to as individual account plan since each participant has a

separate account for accruing plan contributions, and they bear the investment risk)

Simple - $11,500/$2,500

401(k)

Profit Sharing

Here are some examples of DC plans-Defined Contribution Plan Types:

The maximum contribution to an employee’s account during plan year 2011 is $49,000. With the catch up provision, for employees age 50 and older their maximum is $54,500


Integrated Profit Sharing Plan

Age-weighted Profit Sharing Plan

Cross-Tested Profit Sharing Plan (also referred to as Super Integrated, New Comparability or Tiered Allocation)

Profit Sharing Plans


Profit Sharing Plans: provides the maximum flexibility in

employer contribution. A specified contribution is not required

each year. The employer may vary the contribution from year-to-

year or not contribute at all, to reflect the cash flow profitability of

the practice or other business considerations

Minimum Contribution: None

Maximum Contribution: 25% of total payroll

Maximum Allocation to an Individual: Lesser of 100% of W-2 or $49,000 (indexed)


What is a New Comparability Plan?


A profit sharing plan in which the employees are divided into groups• The contribution varies for

each group (i.e., 9% for owners & 3% for others)

• You can use any distinction including every employee being a separate class.

Who is the target audience for such plans?•Works very well for professional firms, physician groups, attorney, etc.•Target group should be older than a significant portion of their employees•Allows maximum contributions for target group while maintaining flexibility in contribution amount•Those seeking to defer current income to reduce Federal & State taxation

For Internal Use Only: Not for Public Distribution© 2011 | ExpertPlan | Retirement Plan Services 7

Are there discrimination tests?

The discrimination test is passed if the employees in the favored groups are older than the employees in the less favored groups with lower contribution percentages.

Allocation to non-highly compensated employees must be at least 1/3 of that provided to HCE’s or 5% (if less)

Absolutely! - It works best for 401(k) plans in which the highly compensated employees need to get a higher contribution

Can New Comparability be used with a 401(k) Plan?

Paired with a “safe-harbor” employer contribution of 3% of pay, it allows the highly compensation employees (“HCE’s”) to maximize their deferrals ($16,500 for 2011 plus catch-up, if applicable)

The plan is tested for nondiscrimination on a cross-tested basis

This allows the plan to offer a higher contribution rate to older participants as the contributions are converted & tested at retirement age.


Dr. Dan 56 $245,000.00 $32,500 13.27% $54,500.00

Dan’s Wife 51 $64,000.00 $10,656 16.65% $32,656.00

DH1 42 $53,000.00 $2888 5.45% $5,538.50

DH2 39 $48,000.00 $2616 5.45% $5,016.00

Sec 26 $32,000.00 $960 5.45% $3,344.00

Asst 2 28 $13,000.00 $390 5.45% $1,358.50

Asst 1 23 $10,000.00 $300 5.45% $1,045.00

New Comp Profit Sharing Allocation Example


Employee Age Compensation Contribution WITH new

comp max numbers

Ps % Total w/Max


Defined Benefit Plans


Defined Benefit Plans: promises to provide a participant a monthly

benefit beginning at retirement and payable as long as he lives. The

amount of this benefit is usually based years of service and how

much the participant earned during his highest-paid three

consecutive years of employment. The maximum annual lifetime

benefit payable to participant with a retirement age of age 62-65 is

$195,000 in 2011.

DB plans maximize the contributions to older employees

DB plans provide employers with the potential for much higher contribution levels than defined contribution plans.

There are two types of Defined Benefit Plans

Cash BalanceTraditional


Defined Benefit Plans explained


• Ideal for Sole Proprietors/100% Owners with no rank and file employees• Contributions can be generated as high as $250,000 depending on age on the individual*• Can be paired with a defined contribution plan to• increase retirement savings and tax advantages**• Put your spouse on the payroll – increase your contributions and tax savings!

• Sole Proprietors/100% Owners over the age of 35 looking to maximize contributions/tax savings

• Sole Proprietors/100% Owners who have several years of past earnings history and want to shelter ALL or MOST of their earnings


Defined Benefit

Why the higher db contribution?

• Annual benefit is defined as an accrual of a monthly benefit payable at retirement age, based on current and/or past compensation history.

• Maximum benefit is based on an annual benefit payable every year for life starting at age 62-65. Maximum currently $195,000 (indexed).

• Maximum benefit limit of $195,000 at age 62 has an equivalent lump sum value of over $2,400,000.

• A participant age 52 has only 10 years to make contributions of approximately $200,000 each year to total over $2,400,000 with interest.

• Maximum benefit limit mandates 10 years of participation in the plan. Less than 10 years creates a adjustment.


Example Example

Sole proprietor earning $500,000 age 60 has a

25% SEP Plan. Needs a higher tax deduction

than $49,000. Solution – install traditional defined

benefit plan. New contribution of $200,000 meets

needs of client.


Doctor is a partner in a thriving corporate practice. He/she has also received additional consulting compensation of $50,000 annually for several years. Doctor would like to shelter all $50,000 of this separate sole proprietor income. Solution – install a traditional defined benefit plan for his sole proprietorship. Base benefits on prior historical compensation.

Example Example


Example of Solo DB contributions


Earned Income $50,000 $100,000 $150,000 $200,000 $300,000

Age Annual Contribution

40 $19,000 $38,000 $57,000 $74,000 $74,000

45 $25,000 $50,000 $75,000 $97,000 $97,000

50 $33,000 $65,000 $98,000 $127,000 $127,000

55 $43,000 $85,000 $128,000 $166,000 $166,000

60 $56,000 $111,000 $167,000 $217,000 $217,000

65 $58,000 $115,000 $173,000 $225,000 $225,000


An Employer Can Have Both!

• No restrictions for employers that (a) are NOT Professional Service entities, and (b) with rank and file employees.

• No restrictions for Professional Service entities larger than 25 employees.

• Employers that have no rank and file employees (i.e., sole proprietors), or Professional Service entities with less than 25 employees (i.e. small doctor offices) can have



Sample 2011 Defined Benefit Contribution Limits


$56,880

6565

*Higher contributions over $300,000 can even be generated for older employers

with a prior earnings history

**Defined Contribution contributions would likely be restricted to 6% of net

earnings PLUS 401(k) contributions

6060

5555

5050

45454040

3535

$22,752

Max Contribution

Tax Savings

$29,864$38,864

$50,793

$66,384

$86,761

$90,142

$74,159$97,159

$126,982

$165,959

$216,902

$225,356

AgeAge

• Contributions are mandated by law. Actuarial computations needed and annual certification required. Much less flexibility.

• Maximum contributions depend on age and compensation of individual with annual contributions for one individual as high as $200,000. The older the individual, the younger the assumed retirement age, the higher the potential.

• Ultimate benefit totally dictated by plan terms. Employer responsible for all investment returns.


Reason for Using a Combined DB/DC Plan


With a Defined Benefit Plan the

benefit provided at retirement is

subject to a benefit limit. ($195,000

for 2011). For this reason Defined

Benefit Plans generate

contributions which favor older

employees.

Defined Benefit contributions are

not limited in amount like Defined

Contribution plans.

Flexibility to design classes of participants that will receive benefits at different levels.

The continued opport- unity for participants to regulate their contributions by their elective deferral and catch up contributions.

A smaller allocable share of costs for

employees.

A higher total contribution amount

in both plans for owners


What’s hot today - Cash Balance Plans - A History


8585

Bank of America established first Cash Balance plan 1985

9393

Dept of Treasury issues “Safe-Harbor” guidelines under 1.401(a)(4)-8(c) for cash balance plans

9696

IRS issues Notice providing Safe-Harbor guidelines for interest rates for cash balance plan

9999

IRS puts moratorium on issuing determination letters to cash balance plans

0202

Dept of Treasury issues 75 page document saying cash balance plans do not discriminate against older workers and issues proposed regulations on conversions of defined benefit plans to cash balance

0404

Dept. of Treasury issues proposed legislation for Cash Balance Plans

0606

Pension protection Act formalizes Cash Balance Plans as a qualified pension plan

0303

Several cash balance plans in litigation over rates of accrual and whipsaw issues, and age discrimination (Bank of America, Xerox, IBM, CBS)

IRS has yet to issue regulations providing specific guidance, but is now issuing determination letters

According to economists at the Federal Reserve

Board, cash balance plans account for 25%

of all participants in defined benefit plans, and 40% of all assets

in defined benefit plans


So what is a cash balance plan

• By Law Cash Balance Plans Are a Form Of Defined Benefit Plan• Benefits may require PBGC insurance• Normal form of benefit for married participants is joint & survivor • Benefits must be properly funded every year• Requires services of an enrolled actuary

• Benefits Are Based On A Hypothetical Account• Account is credited with an annual contribution• Account is credited with an interest credit which is defined by the plan

(generally around 5%)

• Accrued Benefit is in the form of a Lump Sum Distribution

• Accounts Are Backed By A General Pension Trust Managed By Trustees Not Participants



Example Maximum Contributions



Interest crediting rate


Pension Protection Act of 06

Pension Protection Act of 06

Not Less than 0% and

Must be a “market rate”

Common Choices

Common Choices

7-Year Treasury Rate + .25% = 3.3%

30-Year Treasury Rate = 4.56%

Third segment rate = 6.75%


Interest Crediting Rate Factors


Actual ROR (%) 4.56% 5.00% 2.00% 00.0% -2.00% -5.00%

Contribution $75,000 $75,000 $75,000 $75,000 $75,000 $75,000

Actual ROR ($) $3,420 $3,750 $1,500 $0 $(1,500) $(3,750)

EOY Assets $78,420 $78,750 $76,500 $75,000 $73,500 $71,250

Target Funding $78,420 $78,420 $78,420 $78,420 $78,420 $78,420

Over/(Under) Funding $ 0 $330 $(1,920) $ (3,420) $(4,920) $(7,170)

Target


How They Work (Best)

• Targeted Participants (Usually The Owner) Must Generally Be Older Than Other Participants.

• Targeted participants do no need to be “old”: just need some younger employees.

• Contribution Credits Are Higher For Targeted Participants

• Limits Are Based On Defined Benefit Limits• Can generate contribution credits in excess of $200,000 depending on

age of participant

• Testing Required (To Ensure “Non-Discrimination”)

• Testing Works Best When Combined With New Comp 401(k) plan• 401(k) Profit sharing contributions are in addition



More Powerful than New Comp

For Testing Purposes, 1% Equates to Less than 1%• Push large benefits for owners to Cash Balance• Push Profit Sharing benefits to Non-Owners• Enables owner to double or triple what he/she could have gotten from

New Comp alone

Example – Real Case

•36 year old doctor, earning $245,000

•7 employees ranging in age 25, 29, 32, 34, 36, 42 total compensation $162,400

• Design – put wife on payroll for small compensation to “split” testing

• Give doctor maximum under cash balance. Because of age, 26%

• Give employees minimum under cash balance to meet 410(a) 26, 2.5%

• Give employees per capital $1000 under profit sharing, plus harbor 3%

• Give doctor total 5% under profit sharing (cappe at 6% deduction combined plans)

• Give wife total benefit - $93,430 (with deferral); cost to other - $16,057; ratio 83%



Example 1 – The Numbers!


Principals

401(k) Deferral $16,500

Safe Habor $ 0

Profit Sharing $12,250

Cash Balance $64,680

Total $93,430

Rank & File

401(k) Deferral N/A

Safe Habor $ 4,872


Cash Balance $4,185

Total $16,057

Benefit Ratio 85.33%


Extreme Benefit Levels

Sample Maximum 415 Sum Annual Accruals for Defined Benefits Plan with Retirement Age= Age + 5

• Age 57 - $184,398• Age 58 - $180,363

Sample Maximum 415 Lump Sum Annual Accruals for Defined Benefit Plan with Retirement Age = Current Age

• Age 62 - $241,000• Age 63 - $235,727

Maximum Contributions Scale Up With Participation/Age• Example – Real Case• 2 doctors each age 54 earning $218,000 each

• 3 employees ranging in age 31,33,34 total compensation $92,342 • Give employees minimum under cash balance to meet 401(a) 25, 2.5%• Profit Sharing structured safe harbor 3% non-elective• Give doctor total 5% under profit sharing (capped at 6% deduction combined plans)

plus $22,000 each elective deferral• Give employees 3% safe harbor plus 4% profit sharing (needed to meet Gateway

Test)• Doctors total benefits - $371,000 (with deferral); cost to others - $8,772; ratio 97%



Principals (2)

401(k) Deferral $44,000

Safe Habor $13,080


Cash Balance $305,200

Total $371,000

Rank & File

401(k) Deferral N/A

Safe Habor $2,770


Cash Balance $2,309

Total $8,773

Benefit Ratio 97.69%


DB Plan Features DC Plan Features

Cash balance plans are designed to leverage advantages of DB and DC plans

Employer retains tax advantages on investment returns

Efficiency of DB funding

Accrued benefit cannot decrease

Reduce cost volatility

Valuable benefits for a mobile workforce

Level accrual pattern rather than back loading towards end of career

Portable, account-based plans that are easy to understand


Common Concerns

Than

401(k)Than

401(k)Less contribution flexibility

%% Need targeted group of employees

Employer contribution

& actuarial

Employer contribution

& actuarial

Added cost:

Pooled and

5%Pooled and

5% Less investment flexibility


Common Concerns

• Cash Balance Plans Require Contribution Commitments Unless Plan Is Amended

• Should Expect To Pay Up To 10% Of Compensation To Rank And File

• Compared to huge dollars generated for targeted participant's), the tax benefits are still tremendous

• Two Plans, Two annual admin fees

Key Features

• Assets are portable and creditor protected

• Contribution amounts should not change more frequently than every 3 years.

• Underlying concern: what if cash flow changes?

• Reduce 401(k)

• Amend plan

• Freeze plan

Other Issues

• Funding Deadline - Earlier of 8 ½ months after plan year or tax filing date of corporate return

• Contributions determined by actuarial certification

• Participants normally receive account balance on termination

• Guaranteed Interest Credit is required



Is a Cash Balance Plan tax-efficient?


Plan

9% to employees versus Uncle Sam

91% to Owners

($455,000)

No Plan

40% tax($200,000)

60% to Owners

($300,000)

$500,000

40%tax bracket

The tax savings with a well designed pension program can be startling


Next Steps to Consider

• It starts with a plan designed strategically for your corporate objectives and demographics

• Send us your census information• Upon receipt of the census, a member of ExpertPlan’s team of

actuaries and pension consultants will create sample illustrations based upon your desired objectives and the possibilities.

• Once completed, we’ll setup a conference call to go over our findings, explain the options, and then perhaps modify the illustrations based upon an interest in contributing more or less.

• Plans will generally be setup with 4-6 weeks.


Next Steps

If you would like additional informational or to discuss having a no obligation illustration prepared for your practice please contact:

Tom Zgainer

Sr. VP Sales and Business Development

ExpertPlan, Inc.

[email protected]

480.585.6601


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