The Pandemic and Your Pension Plan 

Why Defined Benefit Pension Plans are more valuable then Ever

As entrepreneurs, the pandemic has uniquely impacted every corner of our businesses and our lives.  It has created stress and anxiety, upheaval, loss, new business models, migration from urban centers to suburban and rural locales and in our business, has removed the need for a centralized location.  Just a few weeks back, I had six 'Zoom' calls on the same day in six different states spread out across four separate time zones.  Pre-pandemic, I could never have imagined such efficiency. 
 

While it has been a very difficult environment for many traditional business, the restrictive setting has forced innovation and creativity, and ultimately adaptation. Some business survived, some failed and some have thrived and continue to do so.  Many small business' have experienced record financial outcomes.  With these large increases in revenues, the small business owner is left to figure out how to optimize the utility of their increased revenue.  This brings interesting planning opportunities for us financial professionals and tax planners.

 

One of the biggest questions (and opportunities) right now has to do with business retirement plans, both the popular 401(k) and the fast growing pension design, the Cash Balance plan.  Business owners want to (and in some states are required to, The State of the State Retirement Plans) offer retirement plans to their employees.  It is well known that these benefit plans help incentive and retain staff and provide an excellent setting for tax advantaged saving and investing.  But the question of what the right type of plan is TODAY for these newly thriving business' can feel overwhelming.
 

There is good news.  Back in 2019, when the CARES Act passed, it removed a legacy barrier to plan formation, the December 31st deadline for calendar year plans.  Removing this has solved a major planning problem which is the delay between December 31st and when the business owner and their CPA determined their annual compensation.   The CARES Act extended the deadline to implement and fund a new plan to the employers tax filing deadline, including extensions.  For plan designers like us at Integrated Pension Services, this means we'll be helping our partner advisors, CPAs and their clients to put together 2021 retirement plans potentially until as late as September 15, 2022.  
 

Think about the planning opportunity before us.  Because we'll know the 2021 (and prior) information early in 2022, we can design customized employer contribution arrangements with perfect tax-based hindsight!  The results of these designs may still end up being a common single-plan design, like a 401(k) profit sharing plan, but offers the opportunity to explore more creative formulas and plan types.  

The most common "sophisticated" solution we're implementing are DB/DC Combo plans.  These pair a 401(k) Profit Sharing plan (with an advantaged profit sharing formula) with a second plan in the form of a Cash Balance pension plan.  These are a modern form of a defined benefit plan. When structured properly, these plans create huge tax advantaged savings opportunities. 

 We're commonly structuring plans where the business owners and "favored few" are putting away hundreds of thousands of dollars into these plans.  Over time, this can work out to several million dollars in savings and depending on their state, can save as much as 50% in income taxes.
  
While almost any business could benefit from deferral through a retirement plan, this more sophisticated DB plan, is going to be more interesting to employers who have most of these characteristics:

• Robust and, as or more important, consistently high cash flows
• A strong desire/need to minimize income taxes, even if it means increasing benefits to staff
• As a minimum "rule of thumb", a desire from the business owner to save $100k or more in tax advantaged savings annually for themselves, with an idea that these will be made every year for 7-10 years OR longer
• Understanding that these are long term investments that will not be accessible until retirement
  

If you're a business owner reading this, including financial advisors and CPAs who own their practices, and you meet the above criteria, this can be a very powerful planning tool that needs exploration.  If you're in the latter camp and would like help in this area, we're here for you.  Just reach me at Jason@integrated-pension.com OR at (978) 847-0140 Ext. 820.  

I'm on the Radio! Hear a 30 minute interview discussing Cash Balance Plans from 'The 401(k) Study Group'!

Last week I was lucky enough to be interviewed on the radio by Chuck Hammond of The 401(k) Study Group and we discussed Cash Balance plans.  It is a continuation from the previous posting on this blog about Cash Balance plans.  Hope you enjoy listening to it.  Linked Here.

http://www.blogtalkradio.com/the401kstudygroup/2014/10/10/cashing-in-on-cash-balance

Best - Jason

Cash Balance Plans - Simplified

So, what's all of this noise about this "new" kind of Retirement Plan that's all the rave, called a Cash Balance Plan and how do I 'Cash In'? 

The following information is meant to be informative, while not necessarily all encompassing.

What is a Cash Balance Pension Plan?
A cash balance plan is a type of Defined Benefit (DB) plan that looks and feels like a Defined Contribution Plan (DC) such as a 401(k) or Profit Sharing Plan.  However, just because it looks like a DC plan doesn't mean that it is one, in fact it has more similarities to its' brother the traditional DB pension than it does to its' cousin the 401(k) Plan.  Like traditional DB plans, Cash Balance plans are backwards-looking in that that they guarantee a determinable benefit to eligible participants and use annual contributions plus investment earnings to get to that end benefit at some later date. 

What do you mean it looks/feels like a DC plan?
The allocation formula and the promised benefit are stated as a hypothetical account balance.  They are hypothetical because they do not reflect the actual contributions to and gains/loses allocatable to the account.  Rather they are attempting to give the participant a fair estimate of what their "balance" is in the plan.  Realistically, the benefit they receive is the predetermined balance defined by the plan that won't be achieved until that participant reaches retirement age.

How does it work?
Like all DB plans, the investments are pooled and set up in a trust, allowing for economies of scale to be gained on investment expenses and eliminated the need for "daily valued" record keeping.  Also like other DB plans, these plans are tax-qualified under the IRC and governed under ERISA .  They are required to have fiduciaries in charge, namely the Plan Sponsor, Trustee and Plan Administrator and require the use of an Actuary.  Many of these functions can be outsourced as well.

In a typical cash balance plan, each participant's hypothetical account is comprised of two parts; the pay credit and the interest credit.  The pay credit is typically a fixed amount (such as $25k/year) or a fixed percentage of compensation, like 5% for example.  The interest credit is either a fixed or variable rate linked to an index, such as the 30-Year Treasury. 

These contributions are made annually and invested.  The earnings on investments ought to be engineered to achieve the Interest Credit as a return, no more no less.  The goal most often associated with Cash Balance plans is to maximize tax deductible contributions for the owners, key personnel and highly paid group.  Unlike DC plans, however, contribution amounts from year to year can be theoretically unlimited since the contributions over time must equal what is needed to finance (fund) the promised benefit.  This allows contributions to often go well north of the DC Plan 415 limit of $52,000.  Often these contribution amounts could near $200,000/year for an individual person.

Who would use a Cash Balance Plan and why?
Cash Balance plans are popular among companies that are very rich in revenue while maintaining a fairly low number of employees.  Employers such as law firms, professional groups, CPA firms and medical practices come to mind.  These business' often have strong cash flows historically and prospectively, large budgets, relatively low numbers of employees where most of them are making substantial wages (north of $125k for example), have multiple owners or partners, max out on DC contributions and have mostly an older highly paid workforce.

What about costs and other barriers?
The main costs associated with Cash Balance plans are the contributions themselves since they tend to be much higher and are employer funded plans.  Administrative costs are typically not more burdensome than other plan administrative expenses and sometimes less.  Investment expenses are typically low due to the need to pool investments in a trust and the conservative nature of the investing.  Cash Balance plans can be for any type of employer, however, note that they must be contributed to for a minimum of three years.

Hopefully, this was helpful in explaining some of the main points about Cash Balance plans.  Obviously, this was an overview.  If anyone has questions, they can comment on this post or reach me directly at jason.grantz@unifiedtrust.com.