A Consultant’s View Of Qualified Plan Design

William G. Karbon, COPA, MSPA, CPCVice President, Director of ComplianceCBIZ Benefits & Insurance Services, Inc.

Lawrenceville, NJ

What We Will Cover

• Getting to know your client• Client priorities• Plan types• Obstacles to plan design• Case studies

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Getting To Know Your Client

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Getting To Know Your Client• Entity type

• Private sector– For profit (C corp, S corp, LLC, LLP, sole prop)– Not for profit

• Governmental• Impacts

– Compensation– Taxation– Contribution Deadlines– Plan Type

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Getting To Know Your Client• Controlled Group Issues

• Is client under common control with other entities– How is data gathered?– Who determines members of controlled group?– Who is quarterbacking controlled group issues?

• Impacts– HCE determination– Top heavy / Key ee determination– Minimum coverage– Nondiscrimination testing– Types of plan available

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Getting To Know Your Client• Type of business–Manufacturing– Professional firm– Technology– Etc.– Impacts• Plan type• Plan design• Participant expectations

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Getting To Know Your Client• Overview of their business– How long have they been in business?– Stability of revenue– Stability of profits– Need for cash– Impacts• Ability to commit to fixed contribution• Contribution sources

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Getting To Know Your Client• Profile of employees– Need to attract talent– Need to retain certain employees– Turnover– Disposable income– Impacts• Plan type• Benefit formula / contribution allocation• Nondiscrimination  testing• Vesting

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Getting To Know Your Client• Reward system– Cash– Deferred income– Impacts• Contribution sources / allocation• Nondiscrimination testing

• Threats to business– i.e. sensitive to technology or law changes– Impacts• Plan type

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Getting To Know Your Client• Succession plan– Time horizon– Transition business to family or management– Sell to unrelated entity– Impacts• Plan type• Benefit formula / contribution allocation• Minimum coverage• Nondiscrimination testing

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Client Priorities

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Client Priorities• Focus on owners / senior management–Maximize retirement accumulations– Different benefit structures by job classifications– Impacts• Plan type• Benefit formula / contribution allocation• Nondiscrimination testing

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Client Priorities• Flexibility– Impacts• Plan type• Contribution sources / allocation• Nondiscrimination testing

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Client Priorities• Benefit adequacy– Impacts• Plan type• Benefit formula / contribution allocation

• Avoid testing– Impacts• Plan type• Benefit formula / contribution allocations• Contribution sources

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Client Priorities• Attract talent– Senior talent– Specialized talent– Impacts• Plan type• Eligibility• Benefit formula / contribution allocation• Nondiscrimination testing

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Client Priorities• Paternalism– Impacts• Plan type• Automatic enrollment• Contribution sources / allocation

• Accounting issues– Impacts• Plan type• Benefit formula

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Client Priorities• Tax efficiency– Impacts• Plan type• Benefit formula• Minimum coverage• Nondiscrimination testing

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Client Priorities• Employee appreciation of retirement program – Impacts• Plan type• Plan design• Other rights & features

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Plan Type

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Plan Type

• DB sponsor should address some or all of:  –Maximize retirement accumulations– Stable business (preferably mature)– Adequate cash flow–Willingness to accept plan’s investment risk– If GAAP compliant, able to cope with volatile FASB expense and liability results

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Plan Type

• DC sponsor should address some or all of:  – Provide employees with deferral opportunity• Nondiscrimination testing (SH or no SH)• Auto enrollment and escalation

– Contribution flexibility • Amount• Allocation

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Plan Type

• DB/DC sponsor should address some or all of:  –Maximize retirement accumulations• Accumulations exceeding $50,000/year

– Cash Balance vs. Traditional DB– Combo vs. Offset– Nondiscrimination testing opportunities

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Obstacles To Plan Design

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Obstacles to Plan Design

• Statutory Issues–Minimum Coverage• Excludable employees

–Minimum Participation• Meaningful benefits

– Nondiscrimination• 401(k)• 401(m)• 401(a)(4)• 414(s)  

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Obstacles to Plan Design

• Statutory Issues– Top Heavy– Gateway

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Case Studies

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Case Study 1

• High end business consultancy established in 2012

• Come to you in November of 2012 as follows:– At 12/31/2012 – 4 employees• 2 Owners (ages 40 and 48)• 2 Managing Consultants (MCs)

–Will grow to 14 ees in next 12 – 18  months– 2012 Profit - $1.2 million– Anticipated 2013 Profit - $1.5 million

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Case Study 1• Reward system– Owners (each own 50%) – share equally in all forms of compensation

–MCs (compensation > $200,000)• Cash compensation plus variable deferred income

– Analysts & Associates (compensation > $125,000)• Cash compensation

– Administrative support (compensation = $50,000)• Cash compensation and modest deferred income

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Case Study 1 – 2012 Census

Employees Age Service @ 12/31/12

Pay

Younger Owner 40 1 $300,000Older Owner 48 1 $300,0002 MCs 50 1 $200,000Total $1,000,000

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Case Study 1 – 2014 CensusEmployees Age Service @

12/31/14Pay

Younger Owner 42 3 $300,000Older Owner 50 3 $300,0003 MCs 50 3 $200,0003 Analysts 40 2 $150,0003 Associates 30 2 $125,0003 Support 35 2 $50,000

Total $2,175,000

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Case Study 1• Plan sponsors goals–Minimize tax impact of significant profits–Maximize retirement accumulations for owners– Provide for flexibility in annual retirement plan obligation to MCs

–Minimize retirement plan obligations to Analysts, Associates & Administrative support

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Case Study 1• Potential solution– DB Plan• As part of program will allow plan sponsor to address need to minimize tax impact of significant profits and maximize retirement accumulations for owners

– DC Plan• As part of program will allow plan sponsor to address need to provide for flexibility in annual retirement plan obligation to MCs

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Case Study 1• Potential solution – Combine DB and DC Plan– DB Plan• Traditional vs. Cash Balance

– Cash balance allows for equal contributions to owners

– DC Plan• 401(k)/Profit Sharing Plan

– Deferrals allow all employees to achieve significant retirement accumulations

– Profit sharing feature provides needed  flexibility

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Case Study 1• Potential solution – Combine DB and DC Plan– Design Issues• HCE definition

– AVOID top paid group election– Only administrative support will be NHCEs– PROBLEM – Year 1, only owners will be HCEs as there was no 2011 compensation

• Top Heavy– Unless MCs act as officers, only key ees will be owners– If designed efficiently, plan sponsor may be subject to top heavy minimum contribution requirements

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Case Study 1• Potential solution – Combine DB and DC Plan– Design Issues• ADP testing

– If plan is top heavy, use nonelective safe harbor.  Only NHCEs (administrative support) will need to receive SH contribution. 

– PROBLEM, plan effective after 10/1/12 cannot use SH provisions.  May need to use PY testing.

• ACP testing– Employer matching contributions cannot be used in 401(a)(4) general test, therefore, should not provide matching contributions

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Case Study 1• Potential solution – Combine DB and DC Plan– Design Issues• Minimum Participation Testing

– Minimum participation test under Code §401(a)(26) requires 40% of group to participate in CB Plan.  Ultimately, must cover at least 6 employees in plan.  As plan sponsor’s goal is to maximize cash compensation to Analysts and Associates, they can be excluded from CB Plan.

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Case Study 1• Potential solution – Combine DB and DC Plan– Design Issues• 401(a)(4) General Test

– PROBLEM, 1st year the MCs will be NHCEs and are older than the owners who are the only HCEs.  Testing may limit use of Cash Balance Plan.

– After 1st year, the PS contributions to the owners can be adjusted based on testing results and cash flow.

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Case Study 1 – 2012 1st Pass

Employees Comp Cash Balance

Profit Sharing Deferral Total

Younger Owner

$300,000 $82,073 $0 $12,500 $94,573

Older Owner $300,000 $82,073 $0 $12,500 $94,5732 MCs $200,000 $76,500 $45,000 $5,000 $126,500

Total $317,146 $90,000 $35,000 $442,146

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Case Study 1 – 2012 2nd Pass

Employees Comp Cash Balance

Profit Sharing Deferral Total

Younger Owner

$300,000 $0 $37,500 $12,500 $50,000

Older Owner $300,000 $0 $37,500 $12,500 $50,0002 MCs $200,000 $0 $28,745 $5,000 $33,745

Total $0 $132,490 $35,000 $167,490

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Case Study 1 - Results

ER Contribution % to Owners

ER Contribution % to MCs

56.6% 43.4%

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Case Study 1 – 2014 if THEmployees Comp Cash  

BalanceProfit

Sharing Deferral Total

Younger Owner

$300,000 $82,073 $33,000 $17,000 $132,073

Older Owner $300,000 $82,073 $33,000 $22,500 $137,5733 Principals $200,000 $6,500 $15,000 $22,500 $44,0003 Analysts $150,000 $0 $4,500 $15,000 $19,5003 Associates $125,000 $0 $3,750 $7,500 $11,2503 Support  $50,000 $1,500 $9,625 $1,000 $12,125

Total $188,146 $164,625 $177,500 $530,271

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Case Study 1• PS Contribution Includes– TH Minimum of $10,000 for MCs– TH Minimum of $4,500 for Analysts– TH Minimum of $3,750 for Associates– SH Contribution of $1,500 for Support– TH Minimum of $1,000 for Support

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Case Study 1 - Results

ER Contribution % to Owners

ER Contribution % to Non-

owners

65.2% 34.8%

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Case Study 1 – 2014 if NOT THName Comp Cash  

BalanceProfit

Sharing Deferral Total

Younger Owner

$300,000 $82,073 $33,000 $17,000 $132,073

Older Owner

$300,000 $82,073 $33,000 $22,500 $132,073

3 Principals $200,000 $6,500 $15,000 $22,500 $44,0003 Analysts $150,000 $0 $0 $15,000 $15,0003 Associates $125,000 $0 $0 $7,500 $7,5003 Support  $50,000 $1,500 $9,625 $1,000 $12,125

Total $188,146 $139,875 $177,500 $500,021

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Case Study 1 - Results

ER Contribution % to Owners

ER Contribution % to Principals

70.2% 29.8%

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Case Study 2• Small manufacturing company– Business started in 1990– Revenues/profits are cyclical

• Single owner• Two key members of management • Remainder of employees earn modest incomes– Limited discretionary income– High turnover

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Case Study 2• Client priorities– Cash flow is cyclical, avoid long-term fixed costs– Reward owner and management with employer contributions

– Concerned about retirement readiness of non-management employees

– Address ADP testing problems

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Case Study 2 - CensusEmployee Age Service Pay Deferral

Owner 62 22 $170,000 $22,500

Manager 1 45 15 $100,000 $10,000Manager 2 35 10 $80,000 $4,800

Assemblers 1 - 3 35 5 $40,000 $1,600

Operators 1 & 2 30 3 $30,000 $1,200

Laborers 1 & 2 25 1 $25,000 $0

Clerical  30 2 $30,000 $600

Total $610,000 $45,100

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Case Study 2

• ADP Results– HCE ADP % = 10.0%– NHCE ADP % = 3.8%– Need to increase NHCE ADP % by 4.2%

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Case Study 2• Possible solutions– Employees communications• Typically has marginal success

– Automatic enrollment• Limited success• May partially address retirement readiness concern

– Safe harbor / QACA• Need to determine employer contribution budget• Will deferrals increase if SH match is implemented• Opportunity for stacking of match• Nonelective with new comparability

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Case Study 2• Goals– Provide employer contribution of 9% of pay to Owner and Managers

–Minimize overall employer contribution– Encourage all participants to save for retirement

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Case Study 2• QACA / Stacked Match– Pros• Encourages employees savings• Two year vesting on employer contributions

– Cons• Cost is unpredictable • Likely more expensive if employees understand that there is a substantial match on the first 6% they defer

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Case Study 2• New Comparability with Nonelective SH– Pros• Cost is predictable • More effectively leverages SH contribution in favor of owner and managers

– Cons• Immediate vesting• Rewards participants that do not save for their retirement

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Case Study 2 – Stacked MatchEmployee Comp Deferral QACA Discretion Fixed

Owner $170,000 $22,500 $5,950 $6,800 $2,550Manager 1 $100,000 $10,000 $3,500 $4,000 $1,500Manager 2 $80,000 $4,800 $2,800 $3,200 $1,200Assemblers 1 - 3 $40,000 $1,600 $1,000 $1,067 $400Operators 1 & 2 $30,000 $1,200 $750 $800 $300Laborers 1 & 2 $25,000 $0 $0 $0 $0Clerical $30,000 $600 $450 $400 $150

Total $45,100 $17,200 $19,201 $7,200

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Case Study 2 – Stacked Match Results

ER Contribution % to Owner

ER Contribution %

to Managers

ER Contribution %

to All Others

35.1% 37.2% 27.7%

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Case Study 2 – New ComparabilityEmployee Comp Deferral Nonelective

SH PS

Owner $170,000 $22,500 $5,100 $10,200Manager 1 $100,000 $10,000 $3,000 $6,000Manager 2 $80,000 $4,800 $2,400 $4,800Assemblers 1 - 3 $40,000 $1,600 $1,200 $0Operators 1 & 2 $30,000 $1,200 $900 $0Laborers 1 & 2 $25,000 $0 $750 $0Clerical $30,000 $600 $900 $0

Total $45,100 $18,300 $21,000

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Case Study 2 – New Comp Results

ER Contribution % to Owner

ER Contribution %

to Managers

ER Contribution %

to All Others

38.9% 41.2% 19.9%

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Case Study 3• Small business owner– Business started in 2010– Revenues/profits are substantial and growing– Plans to sell company in 5 – 10 years

• Single owner without significant retirement savings

• Spouse and son works for business as well• Employees are attracted and retained by cash compensation– Retirement program is not a priority

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Case Study 3• Goals–Maximize retirement accumulation for owner–Minimize fixed liabilities–Minimize cost for employees

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Case Study 3 - CensusEmployee Age Service Pay Deferral

Owner 52 10 $250,000 $22,500

Owner’s Spouse 50 5 $60,000 $0Owner’s Son 30 5 $70,000 $2,000NHCEs 1-2 30 3 $35,000 $1,000

NHCEs 3-5 45 5 $50,000 $3,000

Total $600,000 $35,500

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Case Study 3• Potential Solution– DB Plan for Owner, Owner’s Son & NHCEs 1&2– DC Plan for Owner’s Spouse & NHCEs 3-5

• Issue– DB Plan fails 410(b) ratio test

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Case Study 3• Solution– Combine DB and DC plans for minimum coverage purposes

• Concerns–Must provide multiple plan gateway– Subjects the multiple plans to the general test– DB Plan must pass Code §401(a)(26) testing

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Case Study 3 – DB Plan

Employee Age Pay DB Benefit DB Cost

Owner 52 $250,000 $200,000 $139,000

Owner’s Son 30 $70,000 $56,000 $9,400

NHCEs 1-2 30 $35,000 $28,000 $4,700

Total $390,000 $153,100

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Case Study 3 – PS Plan

Employee Age Pay PS Contribution

Owner’s Spouse 50 $60,000 $6,000

NHCEs 3-5 45 $50,000 $3,500

Total $210,000 $16,500

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Case Study 3 – New Comparability

ER Contribution % to Owner &

Spouse

ER Contribution %

to NHCEs

85.5% 14.5%

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Case Study 3• Concerns– One participant terminating employment may create substantial testing issues

– If a NHCE terminates, problem if they are replaced by older employee

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Case Study 4• Small business owner– Business started in 2000– Volatile revenues/profits– 25 year old child hired 2nd half of 2010

• Young workforce not motivated by retirement program

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Case Study 4• Goals– Flexibility in employer contribution requirement– Provide opportunity for child to receive substantial retirement plan accumulations

–Motivate employees to contribute to plan

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Case Study 4

• Plan Design for 2011– Non-Safe Harbor 401(k) Plan– PS feature with each participant in their own rate group

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Case Study 4 – 2011 Results

Employee Age Service Pay Deferral PS

Owner 47 9 $300,000 $5,500 $49,000

Sheldon 25 3 $40,000 $0 $2,000Leonard 26 3 $40,000 $0 $2,000

Howard 30 2 $50,000 $1,000 $2,500

Rajesh 31 2 $50,000 $1,000 $2,500

Total $480,000 $7,500 $58,000

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Case Study 4 -2012• 25 year old son of owner making $100,000 enters plan

• Add nonelective SH 401(k) feature–Will allow owner’s child to maximize accumulations in plan

• Add automatic enrollment

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Case Study 4–2012 1st Pass (Cross Test)

Employee Age Service Pay Deferral PS

Owner 48 10 $300,000 $17,000 $33,000

Owner’s Son 25 2 $100,000 $17,000 $33,000

Sheldon 26 4 $40,000 $0 $2,000Leonard 27 4 $40,000 $0 $2,000

Howard 31 3 $50,000 $1,000 $2,500

Rajesh 32 3 $50,000 $1,000 $2,500

Total $580,000 $36,000 $75,000

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Case Study 4 -2012• Cross testing blows up because of 25 year old HCE

• Solution– Allocate using permitted disparity– Cannot use SH contribution to comply with Code §401(l)

– No need to amend plan

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Case Study 4–2012 2nd Pass (401(l))

Employee Age Service Pay Deferral PS

Owner 48 10 $300,000 $17,000 $33,000

Owner’s Son 25 2 $100,000 $17,000 $9,726

Sheldon 26 4 $40,000 $0 $3,891Leonard 27 4 $40,000 $0 $3,891

Howard 31 3 $50,000 $1,000 $4,863

Rajesh 32 3 $50,000 $1,000 $4,863

Total $580,000 $36,000 $60,234

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Case Study 4 -2012

ER Contribution % to Owner

ER Contribution

% to Owner’s Son

ER Contribution

% to all others

54.8% 16.1% 29.1%

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Case Study 4 -2012• Maximizes allocation to owner• Significant allocations to owner’s son• Tax efficient• Flexible

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