Overview of the Pension Protection Act of 2006 as it applies to DB/DC combo plans
PPA ’06 ChangesIncreases Defined Benefit (DB) plan
deduction limits and repeals combined deduction limit when adding a Defined Contribution (DC) plan
Combined plan deduction limit for 404(a)(7) does not apply if the ER Contribution to a DC Plan does not exceed 6% of compensation Could maximize the DB contribution Replaces the old 25% rule
PPA ’06 Changes to DB/DC PlansIf the Employer contributions to the DC plan do
exceed 6% of compensation, the new combined limit of 31% of compensation applies
Starting in 2008, combined deduction limit does not apply to PBGC-covered plans regardless of level of contributions
Non-PBGC plans still subject to the above rules Plans can not elect to be covered by PBGC!Though hiring children over 25 years might help!
Strategy One: Emphasize the DBER contributions to a DC plan, especially 401(k), are
limited to 6% of total compensation (higher if PBGC)The 6% to a 401(k) plan can be used to satisfy top
heavy, safe harbor requirements AND gateway, MAX DB
Strategy Two: Emphasize the DCMaximize the contribution to the owners under a PS or
401(k) plan, compute the percentage of ER contribution as a % of compensation, subtract this amount from 31%.
The difference is the contribution to the DB plan
Two Major Strategies
Aggregation of Plans
THIS IS WHAT MAKES THE COMBO WORK!!!
In addition to designing plans individually to use the new limits, we can combine the plans using “permissive aggregation” thus testing both plans together: This helps pass coverage and discrimination
tests while often reducing the amount given to rank and file
Points to ConsiderThe defined benefit plan can be traditional,
tiered and/or cash balance Traditional/Tiered are based upon historical salary
averages This creates a required annual contribution even if
the compensation drops, while Cash balance plans normally written as a percent of
current compensation, so if comp drops, so does the contribution Easy to communicate to employees in terms of
deposits and what is owed upon retirement or termination
Plan Designs in Action
SEPS are not always a GOOD idea!It takes $196,000 of W-2 compensation to get
to $49,000 in a SEP (25% of compensation)It takes $130,000 of W-2 compensation to get
to $49,000 in a 401(k) ($16,500 plus 25% of comp)
But MUCH lower W-2 compensations to get to $49,000 in a CB/DC Combo arrangementAge 50, $35,000 - Age 55, $33,000$16,500 plus 6% of compensation plus CB costs!!!(No compensation = No required contribution!)Need to be careful when a ER is a sole proprietor
One Person DesignsCombination of Defined Benefit Plan:
Traditional or Cash Balance with a Defined Contribution Plan designed to maximize contributions, the greater of:31% of compensation ($75,950 for 2009) plus
401(k) salary deferrals ($16,500), or 6% of compensation plus salary deferrals in a
401k Plan plus 100% of compensation in the cash balance or DB plan limited by 415 (can be greater than 31%)
Catchup deferrals of $5,500 can be added to both
One Person Designs Cash Profit Balance Sharing 401(k) NAME Contribution Contribution Contribution
Totals -------------- --------------- --------------- --------------- -------------
Up to 31% of Compensation - $245,000 Owner 30.. 43,450 32,500 16,500 92,450 Owner 35.. 43,450 32,500 16,500 92,450 6% plus cost of DB – Comp at $245,000 Owner 40.. 77,979 14,700 16,500 109,179 Owner 45.. 101,912 14,700 16,500 133,112 Owner 50.. 133,195 14,700 22,000 169,895 Owner 55.. 174,077 14,700 22,000 210,777
One HCE Design If the employer is a professional service
corporation with less than 25 employees, then the limits are 6% of comp plus salary deferrals for the 401(k) Plan and Maximum for the Cash Balance/Defined Benefit Plan (or 31% if 401(k) goes over 6%)
If the employer is NOT a professional service corporation with less than 25 employees and covered by PBGC, then the limits are 25% of comp plus salary deferrals for the 401(k) Plan and maximum for the Cash Balance/Defined Benefit Plan
Age Comp PS ContributionSafe
Harbor Deferrals Totals
Dr. S A 68 245,000 25,150 7,350 22,000 54,500Subtotal 245,000 25,150 7,350 22,000 54,500
PA1 B 58 70,000 8,400 2,100 0 10,500PA2 B 48 70,000 8,400 2,100 0 10,500
Subtotal 140,000 16,800 4,200 0 21,000
Er Totals $385,000 $41,950 $11,550 $22,000 $75,500Total ER
% of Comp 10.90% 3.00% Owners % 72.19%
3% Safe Harbor plus 12% profit sharing contribution to everyone Dr. S's PS Contribution limited by 415
One HCE Design-Comp/Comp
Age Comp PS Contribution Safe Harbor Deferrals Totals
Dr. S A 68 245,000 25,150 7,350 22,000 54,500Subtotal 245,000 25,150 7,350 22,000 54,500
PA1 B 58 70,000 4,665 2,100 0 6,765
PA2 B 48 70,000 4,665 2,100 0 6,765
Subtotal 140,000 9,330 4,200 0 13,530
Er Totals $385,000 $34,480 $11,550 $22,000 $68,030Total ER
% of Comp 8.96% 3.00% Owners % 80.11%
3% Safe Harbor plus 6.67% to Rank and File (integrated basis) Dr. S's PS Contribution limited by 415
One HCE Design-Integrated
Age Comp CB Contribution401(k) ER
Contribution Deferrals Totals
Dr. S A 68 245,000 120,000 0 5,500 125,500Subtotal 245,000 120,000 0 5,500 125,500
PA1 B 58 70,000 2,100 8,400 0 10,500PA2 B 48 70,000 2,100 8,400 0 10,500
Subtotal 140,000 4,200 16,800 0 21,000
Er Totals $385,000 $124,200 $16,800 $5,500 $146,500Total ER
% of Comp 32.26% 4.36%Owners %
85.67%
•The Cash Balance Plan •The 401(k) Plan `100% to Class A limited to 415/or passing test `0% to Class A`3% to Class B `catch up salary deferrals `12% to Class B
One HCE Design- Combo Design
Multiple HCEs and EmployeesThe following designs are for a client with one
major owner (54%), two minor shareholders (23% each) plus six rank and file employees
Combination of a Cash Balance Plan, 3% NHCEs, set $ for MSH and Safe Harbor 401(k) Plan , 3% SH plus 3.7% PS to NHCEs
Objective – Exit Strategy for Majority OwnerMaximize the Majority OwnerStructure transfer of Ownership to Minority
Owners
Age Comp CB PLAN ER DEPOSIT DEFERRALS TOTALS
HCE1 55 245,000 230,671 7,350 22,000 260,021
HCE2 42 110,000 11,000 3,300 16,500 30,800
HCE3 41 100,000 11,000 3,000 16,500 30,500
Subtotal 455,000 252,671 13,650 55,000 321,321
NHCE1 35 80,000 2,400 5,360 0 7,760
NHCE2 32 65,000 1,950 4,355 0 6,305
NHCE3 29 50,000 1,500 3,350 0 4,850
NHCE4 39 45,000 1,350 3,015 0 4,365
NHCE5 27 45,000 1,350 3,015 0 4,365
NCHE6 24 30,000 900 2,010 0 2,910
Subtotal 315,000 9,450 21,105 0 30,555
Plan Totals 770,000 262,121 34,755 55,000 351,876
Percent to HCEs 91.32%
Percent of Compensation 38.55%
Clearly identify the client’s objectives
Revisit those objectives frequently (annually?)
Design the simplest plan or combination of plans to meet those objectives
General test designs usually provide better results than safe-harbor design
However, with very small groups these designs require constant tweaking as employees come and go
Exception: Young HCEs will always wreak havoc with a general-tested plan design unless they are specifically excluded from participation. If they are to be included, a safe harbor design may be the best
Owners and partners of different ages may require DB/DC combination designs to meet different objectives
When using a general test design, rarely hurts to cover all employees in the arrangement. Helps with nondiscrimination testing, improves the deductible limit, and helps reduce the variability of year-to-year results.
Caution: May be difficult to amend plan under 1.401(a)(4)-11(g) – AFTAP less than 60% may be a problem
For younger HCEs, it generally makes sense to maximize the defined contribution arrangement, as it is impossible to make up for lost DC contributions. In a defined benefit plan (assuming at least 10 years of participation), a participant can make up for years where the DB was not maximized
Question: Do you “burn” your DB 415 limits for a younger HCE? (Need guidance on MASD (multiple annuity starting date) rule for 415)
Any prior DB plan accruals?Have any members of the controlled or affiliated service group maintained a defined benefit plan in the past?
Continue to maintain existing profit sharing or 401(k) plan?
DB Plan to be covered by PBGC?
Goal in establishing a defined benefit plan?Principals who are 10-15 years from
retirement Younger principals’ goals?Maximizing current take-home pay or savings?Attract or retain key personnel?Any industry-standard plan types or
provisions?Can the business maintain the plan(s) for the
long haul?What about the impact of changes in the
market?
New Limits for 2009Salary Deferral - $16,500Catch-up - $5,500 for those over 50 years
of ageDC Limit - $49,000 annual additions DB Limit - $16,250 per monthCompensation Limit - $245,000Highly Compensated - $110,000Taxable Wage Base - $106,800
Next StepComplete the Request for Information on
our website. We will provide you a side by side comparison of how a combo design can work for your client!
Contact RPS, Inc. at 407-365-3490 or 888-376-7222, or visit us at www.webpensionplans.com
Technical questions can be directed to Jeffrey T. Sparks, QPA, CLU, ChFC, FLMI
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