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Creative Retirement Plan Designs

William G. Edwards, CPA Lance E. Drummond, QPA, QKA

3/20/2014

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Agenda

• Review Tax Qualified Plan Alternatives • Identify Defined Benefit Plan Candidates • Review Plan Design Case Studies

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Defined Contribution Plans

A tax qualified retirement plan funded by employer tax deductible contributions.

Some plan designs permit employee tax deferred or after tax (Roth) contributions as well.

Participant investment direction is permissible. Known as “account balance” plans – participants are entitled to

their accumulated account balance at retirement (i.e., no guaranteed amount).

Generally easy to understand and communicate to employees. Usually cost effective to maintain.

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Profit Sharing Plans • Employer Contributions Only (No salary deferrals)

– 2014 Contribution limit of $52,000 (maximum 25% of eligible compensation) – $260,000 compensation limit (cap for plan purposes) – Plan must be established by fiscal year end (12/31 calendar yr.) – Approved plan document required (prototype, volume submitter, or

individually drafted) – Contributions must be deposited by tax filing date (including extensions) – Eligibility Requirements: Age 21, 1 year of service with 1,000 hrs (may

require 2 years of service if 100% immediate vesting is utilized) – Allocation formula may be any of the safe harbor formulas (pro-rata,

integrated with social security, age-weighted, target benefit), or new comparability (cross-tested; must utilize the general non-discrimination test)

– Loans Permitted – Vesting schedule may apply (must 100% vest with 6 years of service) – Annual Form 5500 Required

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401(k) Plans

• Roth or Traditional Pre-Tax Salary Deferral Plan – 2014 Contribution Limits:

• $52,000 maximum annual additions – code section 415 ($57,500 with catch-up contribution) • $260,000 compensation limit (cap for plan purposes) • $17,500 salary deferral; $5,500 catch-up at age 50

– Plan must be established by fiscal year end (12/31 calendar yr.); deferrals not permitted until plan is established

– Approved plan document required (prototype, volume submitter, or individually drafted)

– Contribution deposit deadline: • ER Contributions – tax filing date plus extensions • EE Contributions – As soon as reasonable; new small ER safe harbor rule of 7 business days

– May incorporate match and/or profit sharing feature

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401(k) Plans (continued) • Roth or Traditional Pre-Tax Salary Deferral Plan (continued)

– Eligibility Requirements: Age 21, 1 year of service with 1,000 hrs (may require 2 years of service if 100% immediate vesting is utilized); for salary deferrals 1 year of service maximum

– Vesting schedule may apply (must 100% vest with 6 years of service)

– Profit Sharing Allocation formula may be any of the safe harbor formulas (pro-rata, integrated with social security, age-weighted, target benefit), or new comparability (cross-tested; must utilize the general test)

– Loans Permitted – Annual Form 5500 Required – Coverage & Non-Discrimination testing apply; top heavy rules apply

(may limit participation of HCE and Key employees)

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Safe Harbor 401(k) Plans • Roth or Traditional Pre-Tax Salary Deferral Plan

– Permits HCE and Key employees to defer up to annual maximum without being subject to non-discrimination testing (ADP/ACP testing)

– Required Employer Contribution (Mandatory): • Safe Harbor Employer non-elective : 3% of compensation for all eligible

employees • Safe Harbor Employer Match*:

– Basic Match: 100% of salary deferrals up to 3% of compensation plus 50% of salary deferrals on the next 2% of compensation (maximum 4%)

– Enhanced Match: 100% of salary deferrals up to 6% of compensation – *Other more aggressive alternative safe harbor match designs are

permitted

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Defined Benefit Plans

A tax qualified retirement plan funded by employer tax deductible contributions.

Participant contributions are not permitted. Plan assets must reside in a pooled account (i.e., participant

investment direction is not permissible). Plan participants are entitled to a specified benefit at retirement, as

defined by the plan document. Generally provides a superior retirement benefit when compared to

defined contribution plans. May be hard for employees to understand and appreciate. Usually expensive to maintain with limited flexibility.

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Defined Benefit Plans (continued) • Employer Funded Retirement Plan

– Benefit Formula results in a benefit payable at retirement age as stated in the plan

– 2014 Contribution limit: based on actuarial assumptions, $210,000 annual benefit cap for a life annuity payable at age 62 with ten years of credited participation

– Plan must be established by fiscal year end (12/31 calendar yr.) – Approved plan document required – Contributions must be deposited by tax filing date or prior to minimum

funding deadline of September 15th – Eligibility Requirements: Age 21, 1 year of service with 1,000 hrs (may

require 2 years of service if 100% immediate vesting is utilized) – Allocation formulas vary widely (most commonly based on years of service

with the employer and/or a percentage of average compensation) – Vesting schedule may apply to accrued benefit (must 100% vest with 6

years of service)

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Defined Benefit Plans (continued)

• Employer Funded Retirement Plan (continued) – Annual Form 5500 Required – Loans Permitted – Employer directs plan investments – Actuary calculates minimum funding limitation annually; funding

schedule required to be attached to Form 5500 (schedule SB or MB)

– Employer bears investment risk – May result in substantially higher tax deductible contributions (well

in excess of the 25% of compensation limit for DC plans) – Favors older and highly compensated employees

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Defined Benefit Plan Candidates • A history of predictable profitability (e.g.,

professional service corporations, etc…) • A history of predictable cash flow • A history of maximizing contributions to an

existing defined contribution plan • A strong desire for additional tax deferred savings • The following employee demographic is helpful:

– Older Highly Compensated Employees with a desire to save (not all HCEs need to have the same desire to save)

– Younger, lower paid rank and file employees

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Floor Offset Plans A floor offset plan coordinates the benefits of

two retirement plans (a DB and a DC plan). The strategy provides a minimum guaranteed

benefit (or “floor” benefit) from both plans combined.

A retirement benefit is described in the defined benefit plan and is reduced (or “offset”) by contributions to a defined contribution plan.

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Floor Offset Plans (continued)

Any remaining benefit after the “offset” to the defined contribution plan is provided by the defined benefit plan.

In many cases, the floor offset plan can be designed so that only the business owners or other key employees receive any benefit from the floor offset plan (i.e., defined benefit plan).

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Case Study Facts: ABC, Inc. Profit Sharing Plan • 2 Owners • 5 Employees

Profit Sharing Objective: Maximize owners’ benefits while minimizing

the cost of employees’ benefits

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ABC, Inc. Profit Sharing Plan Allocation Alternatives

Position

Age

Compensation

Pro-Rata

Integration

Age- Weighted

Cross- Tested

Owner 60 $260,000 $52,000 $52,000 $52,000 $52,000

Owner 45 $260,000 $52,000 $52,000 $20,863 $52,000

Manager 38 $63,000 $12,600 $10,548 $3,496 $3,150

Shift Mgr. 30 $30,000 $6,000 $5,023 $2,103 $1,500

Office Mgr. 28 $26,000 $5,200 $4,353 $2,865 $1,300

Clerk 25 $24,000 $4,800 $4,018 $1,319 $1,200

Receptionist 21 $18,000 $3,600 $3,014 $929 $900

Total $681,000 $136,200 $130,956 $83,575 $112,050

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Case Study

Facts: ABC, Inc. 401(k) Profit Sharing Plan • 2 Owners • 5 Employees

401(k) Objective: Allow owners’ to defer the annual maximum 401(k)

amount regardless of the level of office employees’ deferrals.

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ABC, Inc. Safe Harbor 401(k) Profit Sharing Plan Allocation Alternative

Position

Age

Compensation Salary

Deferral Catch Up Deferral

3% Non- Elective

Cross-Tested

Total Contribution

Owner 60 $260,000 $17,500 $5,500 $7,800 $26,700 $57,500

Owner 45 $260,000 $17,500 $0 $7,800 $26,700 $52,000

Manager 38 $63,000 $0 $0 $1,890 $1,260 $3,150

Shift Mgr. 30 $30,000 $0 $0 $900 $600 $1,500

Office Mgr. 28 $26,000 $0 $0 $780 $520 $1,300

Clerk 25 $24,000 $0 $0 $720 $480 $1,200

Receptionist 21 $18,000 $0 $0 $540 $360 $900

Total $681,000 $35,000 $5,500 $20,430 $56,620 $117,550

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Case Study

Facts: ABC, Inc. 401(k) Profit Sharing Plan • 2 Owners • 5 Employees

DB/DC Combo Objective: Allow owners’ to defer the annual maximum to the

401(k) plan fully funding the profit sharing plan and adding a DB plan.

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ABC, Inc. Safe Harbor 401(k) Profit Sharing Plan with Floor Offset Defined Benefit Plan – Maximize the 401(k) Contribution

Position

Age

Comp. Salary

Deferral Catch Up Deferral

3% Non-

Elective

Cross-Tested

Defined Benefit Contrib.

Total Contrib.

Owner 60 $260,000 $17,500 $5,500 $7,800 $26,700 $91,832 $149,332

Owner 45 $260,000 $17,500 $0 $7,800 $26,700 $35,003 $87,003

Manager 38 $63,000 $0 $0 $1,890 $2,835 $0 $4,725

Shift Mgr. 30 $30,000 $0 $0 $900 $1,350 $0 $2,250

Office Mgr. 28 $26,000 $0 $0 $780 $1,170 $0 $1,950

Clerk 25 $24,000 $0 $0 $720 $1,080 $0 $1,800

Receptionist 21 $18,000 $0 $0 $540 $810 $0 $1,350

Total $681,000 $35,000 $5,500 $20,430 $60,645 $126,835 $248,410

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Case Study

Facts: ABC, Inc. 401(k) Profit Sharing Plan • 2 Owners • 5 Employees

DB/DC Combo Objective: Allow owners’ to fund the DB plan to the maximum

and also provide a 401(k) plan.

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ABC, Inc. Safe Harbor 401(k) Profit Sharing Plan with Floor Offset Defined Benefit Plan – Maximize the DB Contribution

Position

Age

Comp. Salary

Deferral Catch Up Deferral

3% Non-

Elective

Cross-Tested

Defined Benefit Contrib.

Total Contrib.

Owner 60 $260,000 $17,500 $5,500 $7,800 $6,544 $180,019 $217,363

Owner 45 $260,000 $17,500 $0 $7,800 $6,544 $68,617 $100,461

Manager 38 $63,000 $0 $0 $1,890 $2,835 $0 $4,725

Shift Mgr. 30 $30,000 $0 $0 $900 $1,350 $0 $2,250

Office Mgr. 28 $26,000 $0 $0 $780 $1,170 $0 $1,950

Clerk 25 $24,000 $0 $0 $720 $1,080 $0 $1,800

Receptionist 21 $18,000 $0 $0 $540 $810 $0 $1,350

Total $681,000 $35,000 $5,500 $20,430 $20,333 $248,636 $329,899

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Thank You

Questions?

Bill Edwards Lance Drummond (937) 226-0070 (937) 226-0070 wedwards@cshco.com ldrummond@cshco.com Connect with me on LinkedIn Connect with me on LinkedIn