Pension
Trends Volume II, No. 2, May 2001
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Pension
Trends Volume II, No. 2, May 2001
printer friendly
In this issue...
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New Retirement Age: 85
Have negative investments returns caused your clients to push back their plans for retirement? Does that $1,000,000 tax-qualified account balance now seem like an unattainable goal? If your clients have lost confidence that market returns will bounce back in time for their retirement then they may want to consider adding to their nest eggs the old fashion way: contribute it!
Depending on how hard the market downturn has hit their retirement accounts, increasing their defined contribution deposits to the limit (the lesser of $35,000 or 25% of pay for 2001) might be enough. But what if they need contributions of $50,000, $75,000 or even $100,000 or more to meet their retirement goals? The answer is a defined benefit pension plan.
A defined benefit pension plan can generate a qualified plan deduction of well over $100,000 for participants within a few years of retirement. For example, a 57 year-old business owner who has an average compensation of at least $63,000 and wants to retire at age 62 can contribute and deduct up to $120,000 a year with a defined benefit plan. Of course many clients won’t need or want a contribution that large. But a defined benefit plan is advantageous anytime a contribution in excess of $35,000 or 25% of pay is desired.
Some clients might simply be interested in making up an anticipated defined contribution plan shortfall. For example, consider a business owner who wants to retire in 5 years and would like $1,000,000 in tax-deferred accounts at retirement. Your projections show that current accounts will only accumulate to $600,000 and future contributions of $35,000 will only make up about $210,000 of the $400,000 shortfall. Instead, a defined benefit plan can be designed to produce $67,000 annual contributions/deductions which will accumulate to $400,000 at retirement (assumes 6% rate of return). If after a few years retirement assets have recovered such that the shortfall has disappeared, the defined benefit plan formula can be lowered to generate the desired level of contribution. If the business owner needs to keep the defined contribution plan(s) active for the employees then a defined benefit offset plan may be used to accomplish similar results with minimal employee cost – see related article below.
Pension Trends ContentsCross-Tested DB/DC Plan Combinations
In a previous Pension Trends we discussed how a small employer could add a defined benefit plan to an existing profit sharing plan and generate substantial benefits for the owner with no additional employee expense. This same “offset plan” arrangement can be modified to be even more attractive to small business owners concerned primarily with their own net benefit.
In general, when determining the feasibility of a qualified plan on the basis of the benefit to the owner, we try to achieve an owner benefit percentage of at least 70%. The more eligible employees there are, the harder it becomes to achieve this goal, especially if some of the employees are older.
For
example, take the employer shown to the left with an owner making $170,000 and 7
employees whose pay totals $330,000. The owner’s pay accounts for 34% of the
total, so we won’t even get close to 70% with any kind of traditional defined
contribution plan. Since some of the employees are older, a traditional defined
benefit plan is not much help either with only about 44% of the benefit going to
the owner. A “new comparability” profit sharing plan could be used to get
the owner to $35,000 with about $17,000 in employee cost or an owner benefit
percentage of about 67%. This design gets us close to 70% but the total
deduction is only $52,000, which might not generate enough of a tax savings for
the plan to be a net benefit to owner over the long term.
A hybrid DB/DC combination where the defined benefit plan has a split formula (one formula for the owner and another for non-owners) with the benefits offset by a profit sharing plan, produces an owner benefit percentage of over 76%. In addition, the total deduction for the two plans is $125,000, of which over $95,000 is attributable to the owner. Compared to a “new comparability” profit sharing plan, this design increases the benefit to owner by almost 3 times with an employee cost increase of less than 2 times.
* If you are interested in more information about Cross-Tested DB/DC Plan Combinations please call Timothy Ryor at 503.520.0848.
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