presented by: george taylor mspa; maaa; fca; ea georget@uplink

1

PRESENTED BY: GEORGE TAYLOR

MSPA; MAAA; FCA; EA

[email protected]

A Primer on Cash Balance Plans

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TOPICS TO BE COVERED

CASH BALANCE THE BASICS MAKING IT WORK; DISCRIMINATION

TESTING PROPOSAL DESIGNS FROM PROPOSAL TO ANNUAL ADMIN. ACTUARIAL CONSIDERATIONS (HOW

ARE THE CALCULATIONS DONE) LET’S DO A PROPOSAL TOGETHER QUESTIONS ???

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CASH BALANCE THE BASICS It is a DB plan Accrued Benefits expressed as an account

which grows at a stated rate of interest and a stated contribution. Therefore, benefits are definitely determinable.

Have become quite popular with small employers, as the courts and PPA have eliminated several of the problem areas.

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CASH BALANCE THE BASICS Hybrid plan: Cash Balance; Pension Equity ;

Variable benefit/annuity plan and others. “Applicable defined benefit plan” rules under

PPA. IRS in proposed regulations (REG 154-BG36; issued 12/28/07) refer to them as “statutory hybrid plans”

Plans that are statutory hybrid plans are lump sum based.

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CASH BALANCE THE BASICS Statutory hybrid plans Not subject to the special minimum lump sum

distribution rules under 417(e). Must provide for an interest rate credit of not more

than a market rate of return. At least 3 year cliff vesting Preservation of capital Special rule regarding future rate of return at plan

termination. Age discrimination: similarly situated employees,

disregarding age, must be treated the same

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STATUTORY CB REQUIREMENTSPROPOSED REGS. Safe Harbor for Age discrimination: as of any date

the benefit of any participant would not be less than the benefit of a similarly situated younger participant. Otherwise must test under 411(b)(1)(H)(1).

Would appear that: Job title; ownership %; compensation; location; employer; service could all be used.

Not sure status unrelated to the workplace would work. Has caused little problems when designing a plan.

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STATUTORY CB REQUIREMENTSPROPOSED REGS. Market Rate of Return: Third segment rate Discount rate on 3 month Treas. Bills +175 bp Discount rate on 12 month Treas. Bills +150 Yield on 1 yr. Treas. Constant Maturities+100 Yield on 3 yr. or shorter Treas. Bonds+50 Yield on 7 yr. or shorter Treas. Bonds+25 Yield on 30 yr. or shorter Treas. Bonds+0 bp

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STATUTORY CB REQUIREMENTSPROPOSED REGS. Market Rate of Return Cost-of-Living index as described in 1.401(a)(9)-6,

A-14(b) +300 bp. May be credited more than once a year. What about

distributions made doing the year? Minimum guaranteed rate of return: Reserved A fixed rate of return: Reserved Equity-based rate of return: Reserved ASPPA providing comments or all of the above. I like a fixed rate, and have used 5.5%

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STATUTORY CB REQUIREMENTSPROPOSED REGS. Lots of guidance on conversions, which will

not be covered beyond this slide. The basic principal is that each employee

starts with an account balance/accrued benefit equal to the Actuarial Equivalent (including 417(e) minimum lump sum) of their Accrued benefit.

Will there be 411(d)(6) relief or will the value have to be recalculated each year?

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STATUTORY CB REQUIREMENTSPROPOSED REGS. Regs. will not be effective until PY beginning

on or after 1/1/09. However can be relied on. Any good faith effort to comply is OK but

must follow the law.

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CASH BALANCE THE BASICS ADVANTAGES OVER A STD. DB OR DC

* Higher Contribution addition than a DC plan (amount necessary to fund for 415 DB limit)

* Easy for the employees to understand

* A stated rate of return (must be a “market rate of return”).

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AGE AT

MAX 415 CONTRIBUTION for 2009 (ROUNDED DOWN TO $1,000)

PART: RETIREMENT AGE

55 60 62 65 70

30 $49,000 $45,000 $44,000 $34,000 N/A

35 $64,000 $60,000 $58,000 $46,000 N/A

40 $84,000 $103,000 $79,000 $63,000 N/A

45 $143,000 $103,000 $100,000 $79,000 N/A

50 $165,000 $171,000 $165,000 $103,000 N/A

55 N/A $198,000 $199,000 $170,000 N/A

60 N/A N/A $229,000 $197,000 N/A

65 N/A N/A N/A N/A $220,000

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ADVANTAGES OVER A STD. DB OR DC *Can convert a current DB plan

* Can provide past service benefits

* More meaningful to younger employees and a mobile workforce

*Answers the question: What is in my account? (which will be more difficult to answer for DB plans under PPA). Therefore ideal for the partner plan or the petty owners (who count how many pencils each use).

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ADVANTAGES OVER A STD. DB OR DC* Can have traditional DB benefit for some

of the employees

* Excess earnings reduce future contributions

* May use prior salaries to establish 415 average salary

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CASH BALANCE THE BASICS DISADVANTAGES OF CB/DB PLANS * CB: An Individual Designed Plan; increased

document fees, user fees, delays in getting approval.

*DB/CB: Subject to benefit restriction rules and top 25 HCE LS restriction rules

* CB: Required contribution will not be the same as the sum of the amount going into the accounts (funding whip-saw).

*CB: Must (almost always) be general tested *CB/DB: May be subject to PBGC (could be a good)

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DISADVANTAGES OF CB/DB PLANS *CB/DB: Subject to 401(a)(26)

* CB/DB: Must design plan to not violate 415.

*CB/DB: May limit the deductible contribution to the DC plan to 6% of Compensation

* CB/DB: Must comply with the top heavy DB requirements (usualy provided in DC plan)

*DB/CB: Requires the services of a Actuary

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DISADVANTAGES OF CB/DB

*CB: Can not use wear away for conversions * CB: Three year cliff vesting required *CB: Choosing a “market rate of return” may be

difficult. * CB/DB: Poor earnings may increase cost * CB/DB: Must design conversions to avoid

potential back loading issues (hopefully the IRS, with the recent communications from Congress will change their position). Some relief provided in Rev. Rul. 2008-7

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MAKING IT WORK; DISCRIMINATION TESTING

LIKE CROSS TESTING A DC

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MAKING IT WORK; DISCRIMINATION TESTING

DB/DC: Coverage requirements under 410 (b) DB: Benefiting rules under 401(a)(26) DB/DC: Average benefits testing under 410 (b) DB/DC: Minimum top heavy benefits under 416 DB/DC: Maximum benefit limitations under 415 DB/DC: Gateway considerations under 401(a)4 DC/DC: Deduction limits under 404 DB/DC: Discrimination testing under 401(a)4 DB: Funding rules under PPA

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Benefiting Rules Under 401(a)(26) 401(a)(26): 40% or at least 50 employees must benefit. The Paul Schulz Benefiting Rule:

½% per year of service minimum No one-day wonders Facts and Circumstances

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Maximum Allowable Benefits Under 415 Note the advantage of the defined benefit

maximum is the use of the highest 3 consecutive years compensation Do not need current years earned income to be

as great as prior years Will affect DC annual additions and discrimination

testing

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Deduction Limits Combined Plans Can always deduct 6% of Compensation as a

DC contribution Can always deduct 25% of Compensation to

DB plan (therefore total of 31% if all are in both plans)

Under recent statement from IRS can always deduct 150% of unfunded Target Liability.

Starting 2008 no 404 limits at all for any DB plan subject to PBGC

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DESIGNING PROPOSALS

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ALL PROPOSALS-ASSUMPTIONSValuation Date January 1, 2008

IRC415: Maximum Benefit: Interest% for IRC417(e)-applicable Benefit Forms 5.50%

IRC401(a): Non-discrimination Tests: Testing Age 65

Apply Imputed Disparity to Rate Group Factors No

Defined Benefit Plan: PGBC Requirements Apply 0

DC Plan: Mortality Table RR 95-6 1983 GAM 50/50 BLEND

DC Plan: Retirement Interest% 8.50%

DC Plan: Pre-retirement Interest% 8.50%

DB Plan: Mortality Table RR 2007-67 (2008 PPA - Combined)

DB Plan: Retirement Interest% 5.50%

DB Plan: Pre-retirement Interest% 5.50%

401(a)(4): Plans to Test DB & DC

401(a)(4): Test Basis Benefits

401(a)(4): Test Period Current

401(a)(4): Testing Service Definition Employment

IRC401(a)(26): Maximum Compensation Considered $230,000

IRC415: Maximum Benefit: $Amount $185,000

IRC415: Maximum Annual Account Addition $46,000

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EE Elective

Compensation Sponsor Census

SocSec# First Last Date of Date of Total HCE KEY Deferral Match Subgroup

or EE Id# Name Name Birth Hire Compensation Status Status w/o Catch-Up Contribution #

N/A $320,000.00 $15,500.00 $0.00

123456789 B HCE#1 8/1/52 1/01/90 $250,000.00 1 1 15500.00 1

234567891 A NHCE#1 12/6/64 1/01/00 $40,000.00 0 0 0

345678912 Y NHCE#2 4/23/75

1/01/2002 $30,000.00 0 0 0

Proposal #1 Data

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Proposal #1 current New Comp planMax HCE (30,500) and 3.3% for NHCE

401(A)(26)TEST NA

IRC 415 LIMITATION TEST PASS

410(B) TEST PASS

RATIO BENEFITS TEST RESULTS PASS

AVG BEN TEST N/A

401(A)(4)AVERAGE BENEFITS TEST: PASS

401(A)(4) TESTING: AVG. BENEFITS TEST: PASS

NAR & MVAR TEST PASS

DC PLAN GATEWAY TEST IF USING RATE GROUPS: FAIL

SPECIAL GATEWAY RULES UNDER 1.401(a)(4)-9(b)(2)(v) N/A

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Proposal #1 current New Comp planMax HCE (30,500) and 4.42% for NHCE401(A)(26)TEST NA

IRC 415 LIMITATION TEST PASS:

410(B) TEST PASS


AVG BEN TEST N/A


401(A)(4) TESTING: AVG. BENEFITS TEST: N/A


DC PLAN GATEWAY TEST IF USING RATE GROUPS: PASS

SPECIAL GATEWAY RULES UNDER 1.401(a)(4)-9(b)(2)(v) N/A

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Proposal #1 Assume it is a CB planHCE=30,500 NHCE=5%401(A)(26)TEST PASS

IRC 415 LIMITATION TEST PASS:LEVEL CONT. TO RET.

410(B) TEST PASS


AVG BEN TEST N/A

401(A)(4)AVERAGE BENEFITS TEST: FAIL

401(A)(4) TESTING: AVG. BENEFITS TEST: FAIL

NAR & MVAR TEST AVG BENEFITS FAIL


SPECIAL GATEWAY RULES UNDER 1.401(a)(4)-9(b)(2)(v) PASS: PRIMARLY DB IN NATURE

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Proposal #1 Assume it is a CB planHCE=30,500 NHCE=6.8%401(A)(26)TEST PASS

IRC 415 LIMITATION TEST PASS:LEVEL CONT. TO RET.

410(B) TEST PASS


AVG BEN TEST N/A





SPECIAL GATEWAY RULES UNDER 1.401(a)(4)-9(b)(2)(v) PASS: PRIMARLY DB IN NATURE

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Proposal #1 Assume Combo: HCE 30500NHCE%: CB=1.05, PS=2.75% 401(A)(26)TEST PASS


410(B) TEST PASS


AVG BEN TEST N/A





SPECIAL GATEWAY RULES UNDER 1.401(a)(4)-9(b)(2)(v) PASS

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Proposal #1 Assume Combo:HCE= 173,000NHCE%: CB=1.05, PS=10%

0

:

Name BIRTH HIRE COMP HCE DB CONT. DC CONT. w/o catch up

HCE#1 8/1/52 1/1/90 250000 1 162,000.00 11,000.00 15,500.00

NHCE#1 12/6/64 1/1/00 40000 0 420.00 4,000.00 0.00

NHCE#2 4/23/75 1/1/02 30000 0 315.00 3,000.00 0.00

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Proposal #1 Assume Combo:HCE= 173,000NHCE%: CB=1.05, PS=10%

401(A)(26)TEST PASS


410(B) TEST PASS


AVG BEN TEST N/A






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Proposal #1 Assume Combo:HCE= 173,000NHCE%: CB=1.05, PS=10%IRC404 Maximum Deductible Contribution

Estimated Defined Benefit Contribution $162,735.00

Estimated Defined Contribution Account Addition $18,000.00

6% Compensation for Defined Contribution Plan Participants $18,000.00

25% Compensation for Defined Benefit Plan Participants $75,000.00


Estimated Total Plan Sponsor Contribution $180,735.00

Estimated IRC404 Maximum Deductible Contribution $180,735.00

IRC404 Maximum Deductible Contribution Limit Test PASS

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Proposal #1- IF NRA 62

Values for All Employees

Defined Defined Employee Plan Total

Benefit Contribution Elective Sponsor Contribution

Census Theoretical Profit-sharing Deferral Matching with

HC Subgroup Contribution Contribution w/o Catch-up Contribution Deferrals

Status # $189,800 $18,000 $15,500 $0 $223,300

1 1 189,000.00 11,000.00 15,500.00 0.00 215,500.00

0 0 400.00 4,000.00 0.00 0.00 4,400.00

0 0 400.00 3,000.00 0.00 0.00 3,400.00

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Proposal #1- IF NRA 62

IRC404 Maximum Deductible Contribution

Estimated Defined Benefit Contribution $189,800.00

Estimated Defined Contribution Account Addition $18,000.00


25% Compensation for Defined Benefit Plan Participants $75,000.00


Estimated Total Plan Sponsor Contribution $207,800.00

Estimated IRC404 Maximum Deductible Contribution $207,800.00

IRC404 Maximum Deductible Contribution Limit Test PASS

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Proposal #1 Assume Combo:

Do not overlook the fact that almost the same plan design can be accomplished by a Combo Traditional DB plan and a PS plan.

DB plan to provide ½% of pay per year of service to all HCE and the Max. 415 benefit to the HCE.

PS plan has each employee in a rate group. Often due to the additional expense

associated with CB plan the client makes this decision.

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PROPOSAL#2-CASE STUDY

Last Date of Date of Total HCE KEY Deferral Match

Subgroup

Name Birth Hire Compensation Status Status w/o Catch-Up Contribution #

N/A $967,086.00 $62,000.00 $0.00

HCE#1 8/1/52 01/01/90 $250,000.00 1 1 15500.00 1

HCE#2 12/6/58 01/01/00 $250,000.00 1 1 15500.00 1

HCE#3 4/23/60 01/01/90 $150,000.00 1 0 15500.00 2

HCE#4 7/5/62 01/01/90 $150,000.00 1 0 15500.00 2

NHCE#1 11/25/70 01/01/90 $36,764.00 0 0 0

NHCE#2 10/14/61 01/01/90 $30,322.00 0 0 0

NHCE#3 4/14/63 01/01/90 $50,000.00 0 0 0

NHCE#4 12/9/38 01/01/90 $25,000.00 0 0 0

NHCE#5 1/1/80 01/01/01 $25,000.00 0 0 0

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PROPOSAL#2-SUB GROUP CONT

Defined Defined

Census Benefit Plan Contribution Plan

Subgroup Retirement Sponsor's

# Benefit Contribution

0 0.00000 -11.75000

1 415.00000 0.00000

2 30000.00 0.00000

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PROPOSAL#2- TEST THE PLAN401(A)(26)TEST PASS


410(B) TEST PASS


AVG BEN TEST N/A






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PROPOSAL#2 CONT. AMOUNT

TOTAL $315,000 $19,633 $62,000

DEFINED PROFIT SALARY

TOTAL BENEFIT SHARING DEFERRAL GROUP

Name COMP HCE CONT. CONT, w/o catch up #

HCE#1 250000 1 162,000.00 0.00 15,500.00 1

HCE#2 250000 1 93,000.00 0.00 15,500.00 1

HCE#3 150000 1 30,000.00 0.00 15,500.00 2

HCE#4 150000 1 30,000.00 0.00 15,500.00 2

NHCE#1 36764 0 0.00 4,319.77 0.00 0

NHCE#2 30322 0 0.00 3,562.84 0.00 0

NHCE#3 50000 0 0.00 5,875.00 0.00 0

NHCE#4 25000 0 0.00 2,937.50 0.00 0

NHCE#5 25000 0 0.00 2,937.50 0.00 0

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ACTUARIAL CONSIDERATIONS

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ACTUARIAL CONSIDERATIONS Need to have a Funded Target Liability of at

least 110% in order to pay lump sums to HCE.

What contribution do you recommend or do you simply communicate the Min & Max?

Dealing with the effect of Funding whip-saw

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ACTUARIAL CONSIDERATIONS Getting valuation done in time to avoid benefit

restrictions EOY or BOY valuation date? EOY makes the most sense. PPA current benefit restriction rules after 2008 is a

problem. Without a fix each year benefit will be frozen (after the plan is five years old).

Thec. Corrections will fix this, and IRS has stated their guidance will look like Notice 2008-21.

Potential change in funding method problem post 2008 PY.

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ACTUARIAL CONSIDERATIONSHOW THE CALCS ARE DONE Let’s look at Proposal #1 PPA segment rates:5.72%, 5.92% & 6.09% Years to Retirement: EE#1: 9 years; second rate of 5.92% EE#2: 21 years third rate of 6.09% EE#3: 32 years third rate of 6.09% Assume lump sum payment at retirement Funding Target Liability at ED=$0 Contribution= $156,947 Amount Allocated= $162,735

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ACTUARIAL CONSIDERATIONSHOW THE CALCS ARE DONE YR#1

YEARS TO RET CONT AT RET

NORMAL COST

EE#1 9 162,000 262,293 156,310

EE# 2 21 420 1,293 374

EE# 3 32 315 1,747 264

162,735 156,947

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ACTUARIAL CONSIDERATIONSHOW THE CALCS ARE DONE YR#2 Assets= $156,947 Target Liability = $166,235 Target Liability*1.5-Assets=$92,406 Target Normal Cost=$157,572 Max. Cont.=($92,406+$157,572) or $249,977 Sum of Account balances=($162,735*1.055 +

$162,735) or $334,420. Recommend Cont= ($334,420*110%-$156,947) or

$210,915 .

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GOING FROM PROPOSAL TO ANNUAL AD.

Or who designed this mess?

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RULES FOR PROPOSALS

Advise the client, often, in writing of the need for accurate data, and the need to advise you of any substantial changes or anticipated changes in data.

Never use permitted disparity Don’t get “cute” Don't use “napkin data” Don’t cut it too close just to prove you are smarter

than the other firm that did a proposal Leave some room Consider PT and short service employees (they are

usually younger and will help the test).

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DOCUMENT DESIGN

Remember it is a DB plan, there is no dealing with it at the end of the year like a New Comp. Plan

Consider not having a 1,000 hour requirement or an EOY requirement to get a Contribution.

May want to state the benefit for the HCE in terms of the 415 limit.

Have the same Elig. Provisions as those who share in the PS plan

In some cases it may be wise to separate the 401(k) plan from the PS plan.

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ANNUAL ADMINISTRATION

It is all about passing discrimination testing Remember the testing is done at the end of the year

so expect surprises Try to work a year in advance. Get the data of all the employees. Look at who will be Elig. next year and who shared

this year and will not share next year. Advise the client, often, in writing of the need for

accurate data, and the need to advise you of any substantial changes or anticipated changes in data

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PROPOSAL#3- CASE STUDY EE Elective

Compensation Sponsor Census

Last Date of Date of Total HCE KEY Deferral Match Subgroup

Name Birth Hire Compensation Status Status w/o Catch-Up Contribution #

N/A $666,551.00 $31,000.00 $0.00

HCE#1 11/11/41 01/01/00 $400,000.00 1 1 15500.00 1

HCE#2 7/7/70 05/01/96 $46,000.00 1 1 5000.00 2

NHCE#1 7/2/80 01/01/01 $45,850.00 0 0 0

NHCE#2 8/19/66 02/14/01 $51,533.00 0 0 0

NHCE#3 7/31/79 03/06/06 $24,292.00 0 0 0

NHCE#4 9/27/62 10/25/04 $26,368.00 0 0 0

NHCE#5 12/30/67 03/22/06 $31,979.00 0 0 0

NHCE#6 7/12/81 06/27/25 $22,130.00 0 0 0

NHCE#7 7/1/65 07/05/06 $18,399.00 0 0 0

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PROPOSAL#3- NEW COMP. PLAN




Census Theoretical Profit-sharing Deferral Matching with

Subgroup Contribution Contribution w/o Catch-up Contribution Deferrals

# $0 $43,368 $20,500 $0 $63,868

1 0.00 30,500.00 15,500.00 0.00 46,000.00

2 0.00 1,840.00 5,000.00 0.00 6,840.00

0 0.00 2,292.50 0.00 0.00 2,292.50

0 0.00 2,576.65 0.00 0.00 2,576.65

0 0.00 1,214.60 0.00 0.00 1,214.60

0 0.00 1,318.40 0.00 0.00 1,318.40

0 0.00 1,598.95 0.00 0.00 1,598.95

0 0.00 1,106.50 0.00 0.00 1,106.50

0 0.00 919.95 0.00 0.00 919.95

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PROPOSAL#3- CB/NEW COMP.




Theoretical Profit-sharing Deferral Matching with

Contribution Contribution w/o Catch-up Contribution Deferrals

$215,450 $29,834 $20,500 $0 $265,784

213,000.00 12,290.00 15,500.00 0.00 240,790.00

0.00 1,840.00 5,000.00 0.00 6,840.00

350.00 3,255.35 0.00 0.00 3,605.35

350.00 3,658.84 0.00 0.00 4,008.84

350.00 1,769.96 0.00 0.00 2,119.96

350.00 1,872.13 0.00 0.00 2,222.13

350.00 2,270.51 0.00 0.00 2,620.51

350.00 1,571.23 0.00 0.00 1,921.23

350.00 1,306.33 0.00 0.00 1,656.33

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PROPOSAL#3- OTHER OPTIONS

OWNER ALL TOTAL OWNER

OTHERS CONT. %

NEW COMP. PS PLAN $46,000 $17,868 $63,868 72.02%

CB/NEW COMP. PS (NO PBGC) $240,790 $24,994 $265,784 90.60%

CB/NEW COMP, PS (WITH PBGC) $259,000 $25,547 $284,547 91.02%

DB/NEW COMP. PS (NO PBGC) $240,790 $25,389 $266,179 90.46%

DB/NEW COMP. PS (WITH PBGC) $259,000 $26,052 $285,052 90.86%

ADDITIONAL COST FOR VS DB PLAN

NO PBGC 0 $395 $385

WITH PBGC 0 $505 $505

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Who are potential clients?

Does my firm go into the Cash Balance Plans?

presented by: george taylor mspa; maaa; fca; ea georget@uplink

Documents

stated rate

bpdiscount rate

rate credit

future rate of return

market rate of returncost

reserveda fixed rate

cash balance plans

segment ratediscount