to Qualified Retirement Plans

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1 Overview: Plan Design Compliance Issues to Qualified Retirement Plans May 19, 2016 Defined Benefit / Cash Balance Plans Q&A (during and after) Grant E. Brown CPC, TGPC, ERPA, CFP Jeffrey A. Brown JD, LLM, QPA, ERPA Sole Proprietors/Self Employed Myth: A Self Employed Person can always sponsor their own plan Reality: The Employer must be determined and sponsor the plan A partner in a law firm can only have a plan if adopted by the partnership Compensation must adjusted SE-tax adjustment Adjustment for employer contributions 1

2 Myth: No Reason a 1 person 401(k) compared to a SEP Reality: 401(k)s can allow for great contributions on less compensation. For S-corps can result in payroll tax savings For Sole Prop potentially higher contribution -availability of loans *careful of solo(k) document if hiring EEs Net Profit Needed for Max Cont. SEP 2016 (assuming $53,000 contribution) $276,043 Net Profit = $212,000 Earned Income 401(k) 2016 (assuming $59,000 (35K+24K) contribution) $184,822 Net Profit = $138,000 Earned Income *S-corp: $2,645 difference in Medicare tax* Eligibility/New Hires SEP and SIMPLE IRA Eligibility SEP IRA Eligibility: Age 21 Compensation in at least 3 of 5 prior years and earn > $600 in current year SIMPLE IRA Eligibility: Current year projected compensation > $5,500 At least 2 prior years compensation > $5,500 2

3 401(k) Eligibility Highly Compensated Employee IRC 410(a)(1): minimum age and service conditions of age 21 and 1 year of service (1,000 hours). Can excluded certain employees if 410(b) coverage testing still passes. 410 (b)(1)(b): ratio percentage test where the percentage of employees who are not highly compensated (NHCE) is at least 70% of the percentage of highly compensated (HCE). Highly Compensated Employee (HCE)-414(q) Compensation > $120,000 for prior year (2015) *Exception: top 20% paid group election OR 5% owner (attribution) Trump Apprentice Inc. Example EMPLOYEE CENSUS Discrimination tests compares HCEs vs. NHCEs: 401(k)-ADP, 401(m)-ACP, 410(b), 401(a)4, 414(s) Can you exclude any employees? 3

4 Case Study: Excluding Employees DELIVERING VALUE TO NEW CLIENT 5 HCEs (2 owners & 3 HCE contractors) 15 NCHE Office Staff 37 NHCE Contractors Myth: If I own two business that are unrelated, a plan can be set up for just 1 Reality: Must be aware of controlled group rules All employees of related entities must be treated as if employed by a single employer -may still be possible to have plan cover only one Was able to legally exclude all 40 contractors from plan, since also excluding enough HCEs Contribution Allocation Options for Companies with Employees Myth: Non-discrimination rules mean all get the same contribution. Reality: Now that discrimination is defined under IRC 401(a)(4), owners can benefit more through creative design. A plan is not discriminatory if it does not illegally discriminate in favor of HCE s on the basis of contributions or benefits. 4

5 Dunder Mifflin Paper (now owned by Jim and Michael) Prevailing Wage/Davis Bacon Plans Name Age Comp Pro- Rata Integrated New Comp New Comp Michael k 25,257 29,665 30,184 53,000 Jim k 14,296 13,860 17,086 53,000 Pam k 9,531 8,043 11,391 53,000 Total for Principals $49,084 $51,568 $58,661 $159,000 Andy 55 50k 4,765 4,022 1,898 2,500 Dwight 44 35k 3,336 2,815 1,328 1,750 Darryl 35 30k 2,859 2,412 1,139 1,500 Ryan 26 28k 2,669 2,252 1,063 1,400 Erin 22 24k 2,287 1, ,200 Total for Non-Principals $15,916 $13,432 $6,339 $8,350 Total Contribution $65,000 $65,000 $65,000 $167,350 % to Principals 75.51% 79.34% 90.25% 95.01% Prevailing Wage Plans Case Study: Prevailing Wage Prevailing wage used for public work projects Can offset Safe Harbor contributions with PW Can lead to dramatic tax savings Can allow owners to maximize benefit at little cost DELIVERING VALUE TO NEW CLIENT Construction Company with 40 Prevailing Wage workers. Total prevailing wage were $576,000. Payroll Savings $40K+ Workers Comp Savings of $50K+ Reduced PS costs of $150K+ Additional $120k PS contrib ($110K to owners) 5

6 Government Reporting Myth: 5500s are required for all 401k, 403(b) and DB plans Reality: 5500-EZ Filings are not required for assets under $250k. Who can file an EZ- A one-participant plan One participant plus spouse (not child) Also available for partnership if owner only 403(b) without substantial employer involvement do not need to file 5500 s (unless previously filed) Myth: Companies with over 100 employees need a large plan audit Defined Benefit/Cash Balance Plans Reality: Audit requirement is based on participant count as of beginning of the year. 80/120 Rule It s possible to only cover 30 employees in 300 person company Possible to create 2 plans to avoid required audit Need to still aggregate plans for discrimination testing 6

7 Myth: Defined Benefit Plans are Dead Reality: Defined Benefit and now Cash Balance Plans are alive and well for sole proprietors and small business owners Tax efficient way to shelter significant money. Example: For individual of age 52, she can get deduction of $160,000. The maximum lump sum is $2,363,899 at age Comparable Limits Age 401(k) Profit Sharing Plan Cash Balance TOTAL Tax Savings* $59,000 $230,000 $289,000 $115, $59,000 $180,000 $239,000 $95, $59,000 $135,000 $194,000 $77, $53,000 $105,000 $158,000 $63, $53,000 $80,000 $133,000 $53, $53,000 $62,000 $115,000 $46,000 *taxes 40% tax bracket Defined Benefit Plans DB Sample Statement Determine Benefit Formula (either % of pay or flat $ per year of serv/part) Calc HIGH 3 Year Comp Avg Calc Monthly NRA (max of $17,500/month) Retirement Age XYZ COMPANY DEFINED BENEFIT PLAN 12/31/14 Statement Ben E. Fit Monthly Projected Benefit Monthly Accrued Benefit Vested Percent Vested Accrued Benefit 62 $16,666 $3,333 20% $666 Benefits: 10% of avg monthly compensation per year of service Avg Monthly Compensation: $250,0000/12= $20,833/month Years of Service: 2 years Accrued Benefit Calc: 10% x 2 years x $20,833= $4,167/month Limit on Accrued Benefit: 10% x 2 years x $17,500= $3,500/month Hard to value for Participant Unpredictable Liability for Employer 7

8 Funding What Is A Cash Balance Plan? $ $2.5 age 65 (lump sum of $17,500/month) DB Cash Balance 401(k) Age Why Cash Balance Plans? CB Sample Statement Make Up for Lost Time Higher Contribution Limits Beginning of Year Balance XYZ COMPANY CASH BALANCE PLAN 12/31/14 Statement Ben E. Fit Credited Earnings Contribution Credit Distributions End of Year Balance $100,000 $5,000 $100,000 $0 $205,000 Targeted Contributions Easily Understandable Predictable Liability 8

9 How CB Plans Work Ideal Candidates Name Age Comp 401(k) PS Cash Balance Total Owner 1 60 $265,000 $24,000 $35,000 $210,000 $269,000 Owner 2 55 $200,000 $24,000 $35,000 $120,000 $179,000 Owners want >$50K contribution Staff 1 46 $100,000 Staff 9 26 $38,000 $7,000 $750 $7,750 $2,660 $750 $3,410 Company already contributing Consistent Profits STAFF TOTALS: $29,960 $6,750 $36,710 PLAN TOTALS: $99,960 $336,750 $484,710 Percent of Contribution for Owners: 92% Owners over age 45 Deposit Deadlines Myth: Deposits must be made within 15 days of payroll in a deferral plan Reality: As soon as administratively feasible 401(k): 7 day safe harbor for small plans SIMPLE IRA: Employee salary reduction contributions - within 30 days after the end of the month in which the amounts would otherwise have been payable Prevailing Wage: within 90 days of payroll #1 issue on DOL audits 9

10 Penalty for late deposits Form 5330 filed: penalty= 15% of amounts involved Ex: Company1 month late depositing $1,000 deferrals? What is the penalty? Myth: Sole Proprietors always have until October 15 th to make their plan deposit Reality: Pension plans must satisfy minimum funding requirements (DB and Money Purchase) 8 ½ months after the end of the plan year no extension for weekends/holidays Must also make participants whole with earnings Divorce Valuations and QDROS Qualified Domestic Relationship Orders (QDROs) Exception to anti-alienation provision, allows participant to assign interest to other party Can only ask for features or options available to all plan participants. e.g. valuation date Without a Qualified Order, then participant will be treated as distributee with taxation of benefits and possible early withdrawal penalty if under 59 ½ 10

11 Divorce Pension Valuation Create Wealth with Retirement Savings If plan allows for lump sum distributions, then use the assumptions listed in IRC 417( e) If there is no lump sum available, which is typical of large plans, then use discount rate that reflects low risk rate of investment return Value of Saving Early AGE Contribution Gains Ending Balance Contribution Gains Ending Balance 7.50% 7.50% 22 $5, $0.00 $5, $0.00 $0.00 $ $5, $ $10, $ $5, $ $16, $ $5, $6, $92, $0.00 $0.00 $ $5, $6, $104, $0.00 $0.00 $ $5, $7, $116, $5, $0.00 $5, $0.00 $8, $125, $5, $ $10, $0.00 $9, $135, $5, $ $16, $0.00 $10, $145, $5, $1, $22, $0.00 $57, $823, $5, $30, $438, $0.00 $61, $885, $5, $32, $476, $0.00 $66, $951, $5, $35, $516, $0.00 $71, $1,022, $5, $38, $560, TOTALS $70, $1,022, $155, $560,

12 Questions? Compensation Planning Inc Jeffrey A. Brown JD, LLM, QPA, ERPA Grant E. Brown CPC, ERPA, TGPC, CFP 12