The Pension Protection Act of 2006 added Code Section 414(x) effective for 2010. The type of plan added by PPA of 2006 is called a DB(k) or "eligible combination plan".
The DB(k) melds a 401(k) savings plan with a small Defined Benefit promise. It contains:
(1) A defined benefit equal to 1% of final average pay for each year of the employee's service, with up to 20 years of service counted - so somebody with 20 years of service could earn a 20% of pay retirement benefit;
(2) An automatice enrollment feature for the 401(k) portion. Unless an employee specifically opts out or changes the contribution level, 4% of pay is automatically set as the employee's level of salary deferrals;
(3) An employer match of at least 50% of employee contributions, with a maximum required match of 2% of pay.
As you can see, the new DB(k) is very defined and lacks a certain amount of flexibility, but it might be attractive to certain employers. However, the IRS is just now asking for comments from the pension industry as to these types of plans to help them write the rules pertaining to them. I would guess that regulations will not be published any time soon and therefore none of the retirement plan documents providers will be able to develop plan language to implement these plans until a few months after the regulations are published. So, it might be 2011 before these plans can actually start being utilized.
We will keep you informed about the DB(k) option as it develops.
Friday, August 28, 2009
Sunday, August 23, 2009
A Cash Balance 401(k) Plan Combo Case Study
Prospect told us they wanted to continue to use their 401(k) plan for their 42 employees without much change (3% Safe Harbor plus 1.5% Profit Sharing), but that they would be interested in getting more money put away for the Owners and several key people. They gave us a budget of $50,000 additional for two owners; $30,000 for the other two owners and $10,000 each for three key people or $190,000 total. They will want to do more than that when the economy recovers, but that was their budget for 2009.
We included the seven of them for the $190,000 budget and also covered their 10 lowest paid employees and the cost for them to pass all discrimination testing, etc. was only $6,300. So, $190,000 for principals of $196,300 total is 96.8%.
As a result of providing this solution, the financial advisor who brought us this prospect will end up getting the 401(k) plan too which has over $4,000,000 and will provide the investment for the Cash Balance almost $200,000 per year contribution. And in addition, now the advisor has access to some very successful individuals relative to their personal needs.
Cash Balance additions to existing 401(k)'s for highly successful professional plan sponsors is a great way to give them a legitimate tax deduction and to help them save more for the future. Proactive CPA's should make sure that their high income clients who control their own businesses or professional practices are aware of Cash Balance 401(k) Combo plans and their very large potential contributions
You can go here to see how much of a deduction might be possible:
Cash Balance 401(k) Combo Deduction Calculator
If you would like for us to illustrate to a professional client, how this plan might work, get us a current census of employees (date of hire, date of birth, compensation, ownership percentages) and a printout of their allocations for the last plan year. Email to paul.carlson@plandesign.com
We included the seven of them for the $190,000 budget and also covered their 10 lowest paid employees and the cost for them to pass all discrimination testing, etc. was only $6,300. So, $190,000 for principals of $196,300 total is 96.8%.
As a result of providing this solution, the financial advisor who brought us this prospect will end up getting the 401(k) plan too which has over $4,000,000 and will provide the investment for the Cash Balance almost $200,000 per year contribution. And in addition, now the advisor has access to some very successful individuals relative to their personal needs.
Cash Balance additions to existing 401(k)'s for highly successful professional plan sponsors is a great way to give them a legitimate tax deduction and to help them save more for the future. Proactive CPA's should make sure that their high income clients who control their own businesses or professional practices are aware of Cash Balance 401(k) Combo plans and their very large potential contributions
You can go here to see how much of a deduction might be possible:
Cash Balance 401(k) Combo Deduction Calculator
If you would like for us to illustrate to a professional client, how this plan might work, get us a current census of employees (date of hire, date of birth, compensation, ownership percentages) and a printout of their allocations for the last plan year. Email to paul.carlson@plandesign.com
In Bad Economic Times for a Client, Watch Out for Nasty Top Heavy Minimum Contribution Surprise
For relatively small employers, CPA's need to be aware of a nasty little surprise called "Top Heavy". Often people respond to this statement with "Oh, I know all about the ADP test and how there might have to be refunds of salary deferrals to some of the Highly Compensated Employees."
We are talking about a completely different subject. Suppose a company was really small for a number of years and it made recurring profit sharing contributions for its small staff of mostly key people. Yes, others shared in the Profit Sharing contributions too, but over the years most of them have left the company and have been paid-out or rolled over distributions. The result is that the plan is now "Top Heavy", meaning that the Key Employees have more than 60% of the total account balances. I won't go into it here, but the Key Employee definition is not quite the same as the definition of Highly Compensated Employees. Along the way, probably at the request of the employees, the plan has been modified allowing personal salary deferrals thereby making the plan into a 401(k) plan.
This is not problem as long as times are good and the company continues it generous ways of making Profit Sharing contributions of 3% of pay or more each year. But along comes a recession or difficult business times for the company and the management decides that they will simply skip Profit Sharing contributions for a couple of years. Profit Sharing contributions are, after all, completely discretionary, aren't they? And that is the big surprise!
If a 401(k) Plan is Top Heavy and if ANY of the Key Employees engage in salary deferrals, then the company is going to be faced with making Top Heavy minimum contributions, whether they can afford to or not. Ouch! If any of the Key Employees have made salary deferrals of 3% of pay or more, then the Top Heavy minimum contribution is 3% of the pay of all of the Non-Key Employees. So, for example, if a small company had a payroll of $1,000,000 for all of the Non-Key employees, the Top Heavy minimum contribution would be $30,000.
If the highest rate of salary deferrals is less than 3%, then that percentage becomes the Top Heavy obligation. For example, let's suppose salary deferrals have already taken place for a couple of months before the client discovers that they are Top Heavy. Let's further suppose there is only one Key Employee (the owner) and he or she suspends their salary deferrals after doing $1,000 and their pay for the year ends up being $100,000. So, the salary deferrals is 1% of pay and the Top Heavy minimum contribution becomes 1% of everyone's pay.
When a small business is really struggling to survive in these kind of economic times, the business owner is going to be really upset when they find out they have to make a Top Heavy minimum contribution that they cannot afford and they are going to blame the TPA, investment advisor and maybe even their CPA for not proactively helping this avoid this problem. The solution is easy - don't let any Key Employees do salary deferrals for any part of the Top Heavy plan year.
It takes a bit of foward planning to avoid this situation. First, you have to be aware of whether or not the Key Employees might have more than 60% of the total assets as of the last day of a Plan Year - might be hard to know this since the year end accounting may not be available for a few weeks after the year is over. If they do have greater than 60% on the last day of a year, then the next year is Top Heavy. Second, if it appears likely that the plan will be Top Heavy, to avoid the Top Heavy Minimum, you will need to tell all of the Key Employees that you are going to cease their salary deferrals as of the first day of the Top Heavy year. They can do salary deferrals later in the year if it is determined that the company will be able to afford a Profit Sharing contribution of 3% of pay or more for everybody.
Don't forget to tell the person handling payroll to actually cease the deferrals for the Key Employees as of the first day of the new year.
If the plan is close to being Top Heavy, you may want to routinely cease the salary deferrals of all Key Employees at the beginning of each plan year until you can determine if that year is going to be Top Heavy or not.
We are talking about a completely different subject. Suppose a company was really small for a number of years and it made recurring profit sharing contributions for its small staff of mostly key people. Yes, others shared in the Profit Sharing contributions too, but over the years most of them have left the company and have been paid-out or rolled over distributions. The result is that the plan is now "Top Heavy", meaning that the Key Employees have more than 60% of the total account balances. I won't go into it here, but the Key Employee definition is not quite the same as the definition of Highly Compensated Employees. Along the way, probably at the request of the employees, the plan has been modified allowing personal salary deferrals thereby making the plan into a 401(k) plan.
This is not problem as long as times are good and the company continues it generous ways of making Profit Sharing contributions of 3% of pay or more each year. But along comes a recession or difficult business times for the company and the management decides that they will simply skip Profit Sharing contributions for a couple of years. Profit Sharing contributions are, after all, completely discretionary, aren't they? And that is the big surprise!
If a 401(k) Plan is Top Heavy and if ANY of the Key Employees engage in salary deferrals, then the company is going to be faced with making Top Heavy minimum contributions, whether they can afford to or not. Ouch! If any of the Key Employees have made salary deferrals of 3% of pay or more, then the Top Heavy minimum contribution is 3% of the pay of all of the Non-Key Employees. So, for example, if a small company had a payroll of $1,000,000 for all of the Non-Key employees, the Top Heavy minimum contribution would be $30,000.
If the highest rate of salary deferrals is less than 3%, then that percentage becomes the Top Heavy obligation. For example, let's suppose salary deferrals have already taken place for a couple of months before the client discovers that they are Top Heavy. Let's further suppose there is only one Key Employee (the owner) and he or she suspends their salary deferrals after doing $1,000 and their pay for the year ends up being $100,000. So, the salary deferrals is 1% of pay and the Top Heavy minimum contribution becomes 1% of everyone's pay.
When a small business is really struggling to survive in these kind of economic times, the business owner is going to be really upset when they find out they have to make a Top Heavy minimum contribution that they cannot afford and they are going to blame the TPA, investment advisor and maybe even their CPA for not proactively helping this avoid this problem. The solution is easy - don't let any Key Employees do salary deferrals for any part of the Top Heavy plan year.
It takes a bit of foward planning to avoid this situation. First, you have to be aware of whether or not the Key Employees might have more than 60% of the total assets as of the last day of a Plan Year - might be hard to know this since the year end accounting may not be available for a few weeks after the year is over. If they do have greater than 60% on the last day of a year, then the next year is Top Heavy. Second, if it appears likely that the plan will be Top Heavy, to avoid the Top Heavy Minimum, you will need to tell all of the Key Employees that you are going to cease their salary deferrals as of the first day of the Top Heavy year. They can do salary deferrals later in the year if it is determined that the company will be able to afford a Profit Sharing contribution of 3% of pay or more for everybody.
Don't forget to tell the person handling payroll to actually cease the deferrals for the Key Employees as of the first day of the new year.
If the plan is close to being Top Heavy, you may want to routinely cease the salary deferrals of all Key Employees at the beginning of each plan year until you can determine if that year is going to be Top Heavy or not.
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