Pension Trends Newsletter

Pension Trends Volume XI, No. 2, July 2010

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How to Accommodate Differing Partner Retirement Savings Goals

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How to Accommodate Differing Partner Retirement Savings Goals

	Author Profile
	Alan J. Stonewall FSPA, EA, MAAA This article was written by Alan J. Stonewall, FSPA, EA, MAAA. Mr. Stonewall is a former president of the American Society of Pension Professionals & Actuaries and former chairman and board member of the Actuarial Standards Board. He is a current board member of the Actuarial Foundation. If you would like to contact Mr. Stonewall or any of the other eleven consultants at Independent Actuaries, Inc., please call 503.520.0848 or toll-free at 888.643.5179.

If you are an advisor to a partnership of doctors or other professionals, a Cash Balance (CB) Plan may be a solution to one of their most common problems: some of the professionals want to maximize their retirement savings, while others cannot afford to defer much income at all. How do you accommodate differing partner retirement savings goals? Is it even possible? The answer is yes, it is possible to allow each partner to individually customize his or her tax-deferred savings via a Cash Balance Plan.

Normally, the partners* who would prefer to make substantially larger contributions accept the need to "do what is best for the partnership." The result is a 401(k) plan with a modest employer contribution. The partners use the salary deferral portion of the plan to vary how much they individually save on a before-tax basis. No one is able to make substantial tax-deductible contributions to the plan.

Adding a Cash Balance Plan in combination with the existing 401(k) plan can produce amazing results. With the Cash Balance Plan in place, the partners looking to maximize their retirement savings can defer $100,000 or $200,000 more than they could with the 401(k) plan alone, without causing the other partners to have to increase their savings at all. Consider the following example, based on a real Independent Actuaries, Inc. (IAI) client, with only immaterial changes to remove unnecessary details.

Cross-Tested 401(k) Profit Sharing Plan Only

Employee Name	Current Age	401(k) Plan Employer Contribution	Employee Salary Deferral Contribution	CB Plan Employer Contribution Credit	Total Contribution w Deferrals
Partner A	54	$32,500	$22,000	NA	$54,500
Partner B	57	32,500	22,000	NA	54,500
Partner C	46	32,500	16,500	NA	49,000

Total for Partners		$97,500	$60,500	NA	$158,000

12 Staff		18,564	0	NA	18,564

Totals % of Total to Partners		$116,064 84.01%	$60,500 100.00%	NA NA	$176,564 89.49%

Add a Cash Balance Plan

Employee Name	Current Age	401(k) Plan Employer Contribution	Employee Salary Deferral Contribution	CB Plan Employer Contribution Credit	Total Contribution w Deferrals
Partner A	54	$12,500	$22,000	$161,700	$196,200
Partner B	57	12,500	22,000	190,000	224,500
Partner C	46	12,500	16,500	98,000	127,000

Total for Partners		$37,500	$60,500	$449,700	$547,700

12 Staff		31,500	0	4,620	36,120

Totals % of Total to Partners		$69,000 54.35%	$60,500 100.00%	$454,320 98.98%	$583,820 93.81%

Total Additional Staff Costs
Total Additional Deductible Contribution Opportunity for Partners

$17,556

$389,700

What is a Cash Balance Plan?

A Cash Balance Plan is a defined benefit plan that looks and operates more like a defined contribution plan. Every employee in the plan has an account balance. Distributions are typically made in a single lump sum, eligible for rollover. Each year the account balance is credited with contributions made for that employee and an interest credit. What distinguishes a Cash Balance Plan from a defined contribution plan like a 401(k) plan is that the contribution rates and the interest credits are specified in the plan document.

A typical Cash Balance Plan has multiple contribution "tiers" for the partners and a separate and generally lower contribution tier for staff. The partner contribution tiers might be either percentages of pay (e.g., 90% of pay) or a flat dollar amount (e.g., $175,000). The maximum possible contribution for a partner is age-related and tied to defined benefit plan rules. That is why the amount can be so large. Staff contributions are typically in the 5% to 10% of pay range. While this may appear discriminatory, when tested on a benefits basis, it is not. In fact, each year a test is done to ensure compliance with the nondiscrimination rules.

The interest credit is typically in the 4% to 6% range. Because the interest credit is "guaranteed" by the plan – really the plan sponsor – the funds in a Cash Balance Plan tend to be invested more conservatively than other types of plans so as to reduce volatility and downside risk. Financial advisors often recommend individual participants change their investment mix in the 401(k) plan to take into account their new, fixed income type investments in the Cash Balance Plan, such that their total investment portfolio has the desired mix of equity and fixed income investments.

Summary of Advantages to a Partnership of Professionals

	Saving for retirement on a before-tax basis is the most effective way to accumulate savings. A Cash Balance Plan allows for substantially more before-tax savings than a 401(k) plan.
	Contributions to the Cash Balance Plan can be tailored to the individual goals of each partner. No longer must the partners accept "one size fits all."
	There is no need for the partnership to get rid of or change its 401(k) plan. The 401(k) plan can, and most often should, stay in place just as it is.
	Because nondiscrimination testing is done on a combined basis with the 401(k) plan, adding a Cash Balance Plan does not necessarily mean increasing the level of employer contribution for staff. A combined employer contribution rate of 5% to 10% of pay is typically enough to allow most partners to achieve maximum savings.
	The fixed income nature of a Cash Balance Plan becomes the foundation for a diversified total retirement savings portfolio of equity, fixed income, and perhaps other asset classes.
	As with all qualified plans, the funds in a Cash Balance Plan are protected from creditors.

Cash Balance Plans are the fastest growing segment of our retirement plan practice at Independent Actuaries, Inc. We are in the process of developing a joint website dedicated solely to Cash Balance Plans. If you would like to learn more about how a Cash Balance Plan might be a solution to your client’s retirement savings goals, call or email us.

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* Partnership for purposes of this explanation includes both legal partnerships and corporations of professionals that operate much like partnerships. The true nature of the practice, not the legal form of the entity, is the key.

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This newsletter has been published in order to share general information with our professional contacts. The information presented in this newsletter should not be acted upon without first seeking the advice of a CPA, attorney or other benefit professional.

Pension Trends, Volume XI, No. 2, July 2010
Copyright © 2010 Independent Actuaries, Inc.