Defined Benefit Plans


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Defined Benefit Plans: What Old Is New Again by Jerry Kalish


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Defined Benefit Pension Plans : 

Defined Benefit Pension Plans What’s Old is New Again & Better Than Ever Presented by: Jerry Kalish National Benefit Services, Inc. © 2008

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Fleetwood Mac is going back on tour in 2009, and Defined Benefit Pension Plans are back too! Why? Because they’re part of 21st Century state-of-the art retirement planning designed to Meet legal requirements Be affordable Be flexible Maximize benefits for the owner Provide for family members working in the company Have a full service support system

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Our Agenda What employers need to know, and what you can talk to them about How defined benefit plans work How they fit with other plans

What’s New?What employers need to know : 

What’s New?What employers need to know

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2008 planning began January 1 Not enough comp for S corporation shareholder Not enough time to maximize 401(k) Safe harbor notices (new plan and current plan) SIMPLE vs. 401(k) and when And if your company is a Sole Proprietorship, Partnership, or LLC, then ...

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April 30, 2010: the next major deadline Restatement for EGTRRA changes since 2004 by employers using prototype and volume submitter defined contribution plan Form 8905? Good Faith Amendments? Operate in accordance with Pension Protection Act of 2006 An opportunity to review the plan and see if it can be improved.

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Deadline for depositing deferrals What 15-day rule? 7-business day safe harbor But what if 7-days exceeded?

“Should I stay or Should I go?” : 

Increases in wealth accumulation Type of retirement plan Business cycle Health insurance Social security policy You’re retiring to Tibet and you’ve gone from the accumulation phase to the “decumulation” phase”. “Should I stay or Should I go?”

The new “income for life” focus : 

From accumulation to “decumulation” The annuitization of 401(k) plans Insurance companies gearing up How 1% can make a difference → The new “income for life” focus

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The new focus on fees January 1, 2008 effective date for DOL proposed regs Increased and detailed disclosures about fees Surprise! Are your fees competitive? Inquiring employees will want to know.

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Larue: 9, Employer: 0 1985 Mass Mutual case overturned Participant can be made whole Your fiduciary responsibility is unchanged, and here’s what you can do to minimize your exposure ...

How defined benefit plans work : 

How defined benefit plans work

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How DB differs from DC Only qualified plan to provide guaranteed benefit Fund for monthly benefit at retirement based on annual compensation, years of participation, over lifetime of participant Normal form is annuity: life-only if single, 50% J&S if married Tax deduction based on funding requirements

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The basic pension plan formula Benefits actually paid + Expenses actually incurred - Investment income actually earned = The actual long term cost

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Valuation is just a budgeting tool Actuarial assumptions Funding method

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Actuarial assumptions Probabilities: salary increases, turnover, mortality Estimates: annual earnings Annuity purchase rate (cost of providing $1 per month of income at NRA): e.g., $120.43 at age 65

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Funding Method Systematic method of allocating contributions to plan and to satisfy ERISA funding rules Determines Normal Cost

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Funded status of a pension plan On-going funding uses Plan interest and mortality rates Accounting disclosures use IRS interest and mortality rates Lump sum distribution uses IRS interest and mortality rates Does it matter if plan is 412(i) or traditional?

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What happens when a DB plan terminates Plan assets must equal benefit commitments valued at IRS rates not plan rates What if plan overfunded? What if plan underfunded? Does it matter if plan is 412(i) or traditional?

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Pension plan generations 1st (pre-ERISA (1974): 412(i) fully insured 2nd: (post-ERISA): “traditional” (insurance plus side fund or investment only) Déjà vu all over again (aging Boomers): 412(i) fully insured 3G (Pension Protection Act of 2006): Cash balance pension plans

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412(i) now 412(e)(3) revisited Special type of pension plan which if qualifies is exempt from funding rules Must be funded by insurance contracts: life insurance plus annuity or just annuity Accrued benefit based on policy values Usually generates largest possible tax deduction Still viable despite class action suits

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Traditional DB plan Actuarially funded Subject to ERISA funding rules Can include pre-retirement death benefit using insurance Accrued benefit difficult to understand (and explain) May be subject to Pension Benefit Guaranty Corporation: May not be a bad thing!

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Which one is better? Depends on facts and circumstances But either works only if business is stable, highly profitable, and has consistent cash flow But now we have another choice: Cash Balance plans

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Cash Balance (“CB”) Plans pre-PPA Form of defined benefit plan Called a “hybrid” because it looks like DC but operates as DB Age discrimination issues when DB converted to Cash Balance IRS not issuing determination letters

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CB plans now “legal” Court cases resolved ADEA issues Specifically mentioned in PPA Plan documents now available (individually designed) IRS now issuing letters

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How CB plans work DB plan that specifies the amount of the contribution credited to each participants account and guarantees the investment earnings Each participant has individual account like DC plan And yes, insured pre-retirement death benefit permitted

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How the account grows Employer contribution determined by formula specified in document (% of pay or $ amount) Annual interest credit spelled out in document and not dependent on actual return, e.g., 5% Actual earnings only impact future contributions like traditional DB and partially like 412(i)

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How the contributions are invested Assets invested in pooled account Usually use asset allocation method or target-maturity approach

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CB usually maintained with PS/401(k) Can be tested together Normally provides minimum contribution of 5% - 7% of pay for NHCEs if owners receive maximum CB contribution

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Here are some maximum contributions Age 60-65: $180,000 Age 45-49: $80,000 Age 35-39: $45,000 Actuary determines annual contribution which is subject to ERISA funding rules and may be covered by PBGC (not necessarily a bad thing)

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Why CB best DB plan for professional firm “My contribution” = “my benefit” Same as 412(i) or traditional plan?

Putting the Pieces Together : 

Putting the Pieces Together

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How recent tax legislation encourages DB plans for business owners DB limit has COLA adjustment: $185,000/yr beginning at age 62 (2008) DB and DC benefit limits uncoupled (Section 415) 401(k) doesn’t count against 25% deduction limit (Section 404) 25% combined plan deduction limit removed Extra 6% of pay for DC if not subject to PBGC 25% to DC + cost to fund DB if subject to PBGC

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The DB opportunities Don’t forget about frozen plans Still over 45,000 DB plans: $2 trillion in assets 90% have less than $10 million in assets And, of course, business owners using the new rules

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For the self-employed who receives income from sources other than primary employment Board members University professors with consulting income Writers with royalties or licensing income

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Earned income = compensation for retirement plan purposes Income from trade or business - not passive income Used for sole proprietor, partner, or member of LLC Calculated by subtracting trade or business expenses from total self-employment income Not known until after year end How does that affect PS/401(k) plans?

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Here’s an example:

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And here’s the maximum contribution to one plan:

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And here’s the maximum contribution to both DB and DC using new rules

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Adding a cash balance to existing PS/401(k)

And our attorney wants me to remind you : 

This This presentation is provided for general discussion purposes only and should not be considered tax or legal advice. Always check with a qualified tax adviser to determine the application of the tax laws and rules to your specific situation. For information about our services call: Jerry Kalish National Benefit Services, Inc. 300 West Adams St. Suite 326 Chicago, IL 60606 (312) 419-9080, Ext.3 And our attorney wants me to remind you

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