Large Versus Small DB Plans: A Comparison for DB Practitioners€¦ · • Physicians • Dentists • Certified Public Accountants ... employment tax) –Reduce for retirement plan

Large Versus Small DB Plans:A Comparison for DB Practitioners

Lauren R. Okum, ASA, EA, MAAA, MSPAOwner and Actuary

Premier Actuarial Solutions

Agenda

• Small Plans

• Entity Types

• Controlled Groups and Affiliated Service Groups

• Funding Issues

• ASC 715 Accounting Issues

• Review of Testing Requirements

• Cash Balance Plans

• DB/DC Combo Plans

• Case Studies

1

SMALL PLANS

2

Small DB Plans

• What is a “small” pension plan?– Form 5500-SF instructions

• Fewer than 100 participants at the beginning of the plan year; or

• Eligible to and filed as a small plan for the prior plan year and did not cover more than 120 participants at the beginning of the current plan year

– PBGC premium instructions• Participant count for the current premium payment year is not more than 100; or

• Valuation date for the current premium payment year is not the first day of the premium payment year

– At-risk definition• IRC §430(i)(4)

• 500 or fewer participants on any day during the preceding plan year

– For using the combined annuitant/non-annuitant mortality table• Reg. 1.430(h)(3)-1(b)(2)

• 500 or fewer participants on the valuation date

3

Small DB Plans

• What is a “small” pension plan? (continued)– For purposes of our discussion today, a small pension plan is one with

fewer than 100 active participants and where the goal is to maximize benefits for a select group of participants• Attorneys

• Physicians

• Dentists

• Certified Public Accountants

• Sole proprietors with sufficient net income

4

ENTITY TYPES

5

Entity Types

• Knowing the type of business structure is very important in the small plan market

• Compensation for plan purposes is affected by the entity type– Sole proprietorship: Individual’s earned income reported on Schedule

C, adjusted

– Partnership: Partner’s earned income reported on Schedule K-1, adjusted

– S-corporation: Shareholder’s W-2 income; excludes dividends reported on Schedule K-1

– C-corporation: Employee’s W-2 income

– Limited liability company: Depends on how they’re taxed

6

Entity Types

• Adjustments to earned income for sole proprietors and partners– Start with net income reported on Schedule C or K-1

– Reduce for employer-provided contributions for rank-and-file employees

– Reduce for deduction allowed by IRC §164(f) (i.e., one-half of self-employment tax)

– Reduce for retirement plan deductions for the self-employed individual

7

Entity Types

Plan Compensation for Self-Employed Individuals

1. Net income on Schedule C $553,293

2. Employer-provided contributions for employees

$76,123

3a. Self-employment taxable earnings 92.35% of ($553,293 - $76,123) = $440,667

3b. Taxable wage base $118,500

3c. ½ of self-employment tax 50% of (12.4% x $118,500 + 2.9% x $440,667) = $13,737

4. Retirement plan deduction for self-employed individual, excluding 401(k) deferrals

$199,825

5. Plan compensation $553,293 - $76,123 - $13,737 - $199,825 = $263,608

8

CONTROLLED GROUPS AND AFFILIATED SERVICE GROUPS

9

Controlled Groups and Affiliated Service Groups

• Why are Controlled Groups (CG) and Affiliated Service Groups (ASG) important? If a CG or ASG exists, employees of those businesses are considered one employer for qualified plans– §401(a)(17): Compensation limit

– §415: Benefit limits

– §401(a)(26): Minimum participation

– §410(a) and (b): Eligibility and coverage

– §401(a)(4): Nondiscriminatory benefits

– §416: Top-heavy determinations

10

Controlled Groups

• A Controlled Group is a group of businesses that have common ownership interest

• Types of Controlled Group relationships– Parent-subsidiary: One entity owns 80 percent or more of another

entity

– Brother-sister: In broad terms, there are two threshold to meet:• Common ownership: The same five or fewer individuals own at least 80 percent of

each company under consideration; and

• Identical ownership: The sum of the identical ownership of the five or fewer owners from above is greater than 50 percent

– Combination of above

• IRC §§414(b), 414(c), and 1563

11

Controlled Group Family Attribution

The ownership interest of a: Are attributed to a:

Spouse Spouse

Parent Minor child (under age 21)

Minor child (under age 21) Parent

Parent Adult child (21 or older), if child owns more than 50% of the business

Adult child (21 or older) Parent, if parent owns more than 50% of the business

Grandparent Grandchild (regardless of age), if grandchild owns more than 50% of the business

Grandchild (regardless of age) Grandparent, if grandparent owns more than 50% of the business

Sibling None

12

Affiliated Service Groups

• An Affiliated Service Group is a group of businesses that have some common ownership interest or other relationship

• Key variables in determining whether an ASG exists include:– Working relationship: Does Entity A provide services to Entity B that

are usually provided by Entity B’s employees? Do the entities join together to provide services to the same clients?

– Ownership: Is there any common ownership among the entities? (Sometimes as little as ten percent common ownership will trigger an ASG)

– Management: Does one entity provide management oversight over the other entity? If so, an ASG might exist even if no common ownership

• IRC §§414(m) and 318

13

ASG, HCE, and Key EE Family Attribution


Spouse Spouse

Parent Child

Child Parent (but not In-Laws)

Grandchild Grandparent

Grandparent None

Sibling None

14

FUNDING ISSUES

15

Assumptions

• Prescribed assumptions– Statutory interest rates

• Segment rates – often using a four-month lookback is helpful for estimates

• Yield curve

– Statutory mortality table • Often the combined annuitant/non-annuitant mortality is used for efficiency

• Combined table is only available for small plans with 500 or fewer participants on the valuation date per Reg. 1.430(h)(3)-1(b)(2)

– Substitution of annuity rules• Enrolled actuary must determine liabilities for benefits that are expected to be paid

in a lump sum based on §417(e) segment rates using an “annuity substitution rule”

• “Annuity substitution rule” requires calculation of the present value of the lump sum using §417(e) statutory mortality and current §430 segment rates

16

Assumptions

• Non-prescribed assumptions– Actuarial Standards of Practice

• ASOP 27 – Selection of Economic Assumptions for Measuring Pension Obligations

• ASOP 35 – Selection of Demographic and Other Noneconomic Assumptions for Measuring Pension Obligations

– Requirements under the Pension Protection Act:• Each assumption must be reasonable (taking into account the experience of the

plan and reasonable expectations); and

• Assumptions, in combination, offer the actuary’s best estimate of anticipated experience under the plan

– For small plans, past experience may not be indicative of future experience

17

Assumptions

• Non-prescribed assumptions (continued)– Retirement age

• For small plans, a single assumed retirement age is often used

• Many small plan actuaries assume retirement age at Normal Retirement Age defined in the plan document, provided it reflects the expected retirement dates of the principals and owners

• Most small plans do not offer early retirement (and thus early retirement subsidies)

– Pre-retirement decrements (termination, death, disability)• Principals and owners, who represent the bulk of the liabilities, would not assume

to terminate employment prior to retirement

• Not enough credible experience to determine termination rates for employees

• Many small plan actuaries deem pre-retirement death as immaterial

• Most small plans do not offer special benefits upon disability (and thus disability rates are not needed)

18

Assumptions

• Non-prescribed assumptions (continued)– Salary increases

• For small plans, often no salary increases are assumed

• Principals and owners, who represent the bulk of the liabilities, are often at the §401(a)(17) compensation limit or take the same salary each year

• Actuary should consult with the plan sponsor regarding anticipated experience

– Future interest crediting rate in cash balance plan with variable interest credits• The current rate may or may not be the actuary’s best estimate of future

experience

• Note that the IRS requires the current rate to be used for all testing purposes, but not for funding purposes

– Form of payment• Most small plans offer lump sums, and nearly 100 percent of participants elect

lump sums (based on my experience – not an actual figure)

19

Valuation Date

• Valuation date– Must be the first day of the plan year, unless the plan is a “small plan”

per Reg. 1.430(g)-1(b)(2)

– A “small plan” is defined as a plan that had 100 or fewer participants on each day of the prior plan year

– Often small plans use an end-of-year valuation date• Better coordination of contributions with earned income for sole proprietor plans

• Funding based on actual data versus estimated data

• Simplification of general testing

20

Valuation Date

• Revenue Procedure 2017-56– Effective January 1, 2018, though may be applied for earlier plan years

– Automatic approval for two changes in valuation date, provided there was no change in the valuation date in the four preceding plan years:• A change in the valuation date to the first day of the plan year; or

• A change in the valuation date to the last day of the plan year, if there was a change in the plan year and the valuation date for the prior plan year was the last day of that plan year

21

Valuation Date

• Revenue Procedure 2017-56 (continued)– Automatic approval for a change in the valuation date to the last day

of the plan year if all of these four conditions are satisfied:• Both the enrolled actuary and the business organization providing actuarial services

to the plan have changed;

• The new method is substantially the same as the method used by the prior enrolled actuary;

• The new enrolled actuary can match the prior enrolled actuary’s funding target and target normal cost as of the valuation date for the prior plan year within three percent; and

• The new enrolled actuary can match the enrolled actuary’s actuarial value of plan assets as of the valuation date for the prior plan year within two percent

22

End-of-Year (EOY) Valuation Issues

• Adjustment to assets– Fair market value of assets at EOY, minus

– Current year contributions made prior to the valuation date, minus

– Interest on the contributions at the Effective Interest Rate between the deposit dates and EOY, equals

– Market value of assets for funding as of the EOY

23

For EOY Valuation

1. Fair market value of assets $145,000

2. Current year contributions $10,000

3. Interest on current year contributions

$10,000 div by (1.056^(183-365) – 1) = $277

4. Market value of assets $145,000 - $10,000 - $277 = $134,723


• Liabilities– Funding target and target normal cost are determined as of the EOY

– Funding target is based on the benefit accrued at BOY

– Target normal cost is based on the benefit accrued during the year

– Benefits accrued at BOY and benefits accrued during the year that have been distributed during the year (and are therefore not included in the assets at EOY) are not considering in determining the funding target and target normal cost

24


• Satisfying Minimum Funding Standards– Contributions are adjusted for interest to the valuation date using the

Effective Interest Rate• Discounted if made after EOY

• Increased if made before EOY

25


• Credit balances and Schedule SB– By definition, credit balances are determined as of the first day of the

plan year

– Balances are reported on the Schedule SB as of BOY, even if valuation date is not first day of plan year

– Balances available for use must be adjusted to EOY• Accumulate balances from BOY to EOY using current year’s Effective Interest Rate

• Apply balance reductions

• Discount back to BOY using current year’s Effective Interest Rate

• Accumulate to next BOY using actual return on assets

26


• Credit balances and Schedule SB (continued)

27

For EOY Valuation

1. Balance at BOY $139,459

2. Balance at EOY using EIR $139,459 x 1.0591 = $147,701

3. Balance reductions $0

4. Remaining balance at BOY ($147,701 - $0) / 1.0591 = $139,459

5. Balance at next year’s BOY using actual ROA

$139,459 x 1.0556 = $147,213


• Funding Target Attainment Percentage (FTAP)– For both BOY and EOY valuations, it will be based on the current plan

year’s segment rates

– FTAP = (Assets – Credit Balances) ÷ Funding Target• Credit balances are adjusted to EOY using current year’s Effective Interest Rate

– Results are truncated (round down) to nearest 0.01 percent

28

For EOY Valuation

1. Assets used for funding $479,405

2. Credit balances $147,701

3. Funding target $329,017

4. FTAP ($479,405 - $147,701) / $329,017 = 100.81%


• Adjusted Funding Target Attainment Percentage (AFTAP)– For EOY valuations, it may or may not use the current plan year’s

segment rates, depending on actuary’s interpretation• 12/31/2016 liabilities are used to determine 2017 AFTAP

• Since 12/31/2016 liabilities, use 9/30/2015 rates? (My preference)

• Since 2017 AFTAP, use 9/30/2016 rates?

– Assets include discounted receivable contributions

– Sometimes assets are reduced by credit balances, sometimes not • If Assets ÷ Funding Target ≥ 100 percent, then AFTAP = AVA ÷ FT (assuming no

annuity purchases)

• If Assets ÷ Funding Target < 100 percent, then AFTAP = (AVA – COB/PFB) ÷ FT (assuming no annuity purchases)

– Credit balances are adjusted to next year’s BOY using current year’s actual ROA

– Credit balances include excess contribution added to PFB for current year

– Results are truncated (round down) to nearest 0.01 percent

29


• Adjusted Funding Target Attainment Percentage (AFTAP)

30

For EOY Valuation

1. Fair value of assets at EOY

$479,405

2. Discounted receivables $96,159

3. Assets used for AFTAP $479,405 + $96,159 = $575,564

4. Balances at next year’s BOY

$147,213

5. Amount to add to PFB $96,159

6. Balances used for AFTAP $147,213 + $96,159 = $243,372

7. Funding target $329,017

8. AFTAP $479,405 / $329,017 = 174.93%

Maximum Deductible Contribution

• In general, the Maximum is calculated under IRC §404(o)

• It’s the greater of the following over plan assets:– Funding Target + Target Normal Cost + Cushion Amount

– Funding Target as if At-Risk + Target Normal Cost as if At-Risk

• It’s not always wise to quote the under §404(o), unless you caveat the heck out of it

• It could lead to the plan being way too overfunded– If the plan terminates and the owner is already at the maximum lump

sum payable, you cannot increase benefits for him or her

– Excess assets upon plan termination that revert to the employer are subject to a 50 percent excise tax!

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• If the plan is not PBGC-covered, then the combined plan deductible limit under §404(a)(7) applies will discuss later

• Sole proprietors need sufficient net income to allow the deduction see slides 7 and 8 – Plan compensation cannot be less than $0

– IRC §404(a)(8)(C)

32


• Generally, the goal is to limit the assets to the benefit liabilities on a plan termination basis

• A little overfunding might be right for a particular plan

33

ASC 715 ACCOUNTING ISSUES

34

ASC 715 Accounting

• What does the ASC 715 valuation do?– Determines the expense (or income) that is charged on the company’s

statement of net income

– Determines the liability (or asset) that is reported on the company’s balance sheet

35

ASC 715 Accounting

• Which clients need an ASC 715 valuation?– Plan sponsors that are publicly held

– Private plans that require GAAP accounting• Construction companies with bonding requirements

• Companies with loan covenants

– Ultimately, the auditor is responsible for determining whether your client needs an ASC 715 valuation

36

ASC 715 Accounting

• What’s different for large plans and small plans?– Almost nothing!

– Determination of the discount rate is usually less complex• Old approaches

– Look at AA bonds

– Reflect a corporate bond yield curve, often using an “effective interest rate” calculation

• Current approaches– Provide projected cash flows to auditor, match them to a selected yield curve, and calculate an

“effective interest rate” to use as the single discount rate

– Match projected cash flows to a portfolio of zero-coupon, high-quality corporate bonds that generate sufficient cash flows, and use present value of selected bonds impractical for small or mid-sized plans

37

REVIEW OF TESTING REQUIREMENTS

38

IRC §401(a)(26)

• Under §401(a)(26), a standalone DB plan must provide “meaningful benefits” to lesser of: – 40 percent of the non-excludable employees; or

– 50 employees

• But, in no event, less than two employees, unless there is only one non-excludable employee

• It doesn’t matter if benefiting participants are HCEs or NHCEs

39

IRC §401(a)(26)

• What is a “meaningful benefit”? – Regulations provide no bright line test to determine if benefits being

provided are meaningful

– Instead say based on “facts and circumstances”

– 0.5 percent accrual rate (not CB credit) is considered “meaningful”

40

IRC §401(a)(26)

• Accrual rate – Increase in benefit ÷

– Testing service ÷

– Testing compensation

• For a CB plan, the increase in benefit is the cash balance credit projected to NRA and converted to an annuity

41

IRC §401(a)(26)

• Example– Given

• $600 cash balance credit

• Five percent interest crediting rate

• Compensation = $40,000

• Normal Retirement Age = 62

• Monthly annuity conversion factor at age 62 = 156.59474

– Accrual rate for participant age 30• Accrual = $600 * (1.05)32 ÷ 156.59474 = $18.26

• Accrual rate = $18.26 * 12 ÷ $40,000 = 0.54 percent meaningful

– Accrual rate for participant age 40• Accrual = $600 * (1.05)22 ÷ 156.59474 = $11.21

• Accrual rate = $11.21 * 12 ÷ $40,000 = 0.33 percent not meaningful

42

IRC §§410(b) and 401(a)(4)

• §410(b): Coverage– Requires a certain percentage of Non-Highly Compensated Employees

(NHCEs) to benefit from the plan

• §401(a)(4): Nondiscriminatory benefits– Requires that benefits do not favor Highly Compensated Employees

(HCEs) “too much”

• §410(b) and §401(a)(4) work together to form a single, coordinated nondiscrimination rule

43

Highly Compensated Employees

• §414(q): Highly Compensated Employee– During the current or prior plan year owned more than five percent of

the employer; or

– Earned in excess of $120,000 in the prior year• Adjusted annually for cost of living

• Use the limit for the lookback year – e.g., use $120,000 in 2016 for determining HCE status for 2017

• Use the limit in effect at the beginning of the plan year – e.g., for determining HCE status for July 1, 2016 through June 30, 2017 status, use the 2015 HCE compensation limit

– Family attribution under §§414(m) and 318 applies (same as for ASGs)

44



Spouse Spouse

Parent Child



Grandparent None

Sibling None

45

IRC §410(b)

• §410(b) requires that either:– Plan satisfies the Ratio Percentage Test:

– Plan satisfies the Average Benefits Test;

– Plan does not benefit any HCEs; or

– The employer has no non-excludable NHCEs

• An employee is benefiting only if the employee actually:– Accrues an additional benefit in a DB plan; or

– Receives an allocation of contributions or forfeitures in a DC plan

• Special rule for 401(k)/(m) plans– Employee is considered benefiting if eligible to participate

– It does not matter if employee actually makes a deferral or receives an employer match

46

IRC §410(b) – Ratio Percentage Test

• To satisfy the Ratio Percentage Test, the plan must have a “Ratio Percentage” of at least 70 percent:– Ratio Percentage = NHCE ratio percentage ÷ HCE ratio percentage

• NHCE ratio percentage = number of NHCEs benefiting under the plan ÷ total number of non-excludable NHCEs

• HCE ratio percentage = number of HCEs benefiting under the plan ÷ total number of non-excludable HCEs

– For this purpose, the amount someone is benefiting is irrelevant

47

IRC §410(b) – Average Benefits Test

• To satisfy the Average Benefits Test, the plan must pass both:– Nondiscriminatory classification test; and

• Reasonable classification test (classification for identifying eligible employees must have some reasonable business purpose); and

• Easier Ratio Percentage Test

– Average Benefits Percentage Test (ABPT)• Average benefits for NHCEs must be at least 70 percent of the average benefits for

HCEs

• Include all plans of the employer with plan years ending in the same calendar year, including 401(k) plans, 401(m) plans, and ESOPs

• Few small plans rely on the Average Benefits Test to pass §410(b)

• Small plans commonly need to pass ABPT to pass §401(a)(4)

48

IRC §401(a)(4)

• To pass §401(a)(4), a plan must:– Satisfy §401(k) in case of a 401(k) plan;

– Satisfy §401(m) in case of a 401(m) plan;

– Not benefit any HCEs;

– Have no non-excludable NHCEs;

– Have a safe harbor formula; or

– Satisfy the General Test

49

IRC §401(a)(4)

• For the General Test, we compare EBARs of HCEs to EBARs of NHCEs

• EBAR stands for:– Equivalent Benefit Allocation Rate (aka allocation percentage), if

testing on a contributions basis

– Equivalent Benefit Accrual Rate (aka normal accrual rate), if testing on a benefits basis;

• The basic formula for an EBAR is:– Increase in benefit over the Measurement Period ÷

– Testing Service ÷

– Testing Compensation

50

IRC §401(a)(4)

• For each HCE tested on a benefits basis, a rate group is defined that includes all employees with the same or higher aggregate normal accrual rate and same or higher aggregate most valuable accrual rate

• Each rate group must satisfy §410(b) by either:– Passing the Ratio Percentage Test (i.e., each rate group has a Ratio

Percentage of at least 70 percent); or

– Passing a modified Average Benefits Test

51

IRC §401(a)(4)

• Modified Average Benefits Test– Each rate group is deemed a reasonable classification (i.e., no

reasonable classification requirement)

– Each rate group must have a Ratio Percentage greater than or equal to the lesser of:• The midpoint between the plan’s safe harbor and unsafe harbor percentages; and

• The plan’s Ratio Percentage

– Plan must pass the Average Benefits Percentage Test (ABPT)

52

IRC §416

• Top-heavy plans are required to meet: – Minimum vesting requirements; and

– Minimum benefit or contribution requirements

• Top-heavy determination– DB plans are top-heavy when more than 60 percent of the present

value of accrued benefits as of the determination date are attributable to key employees

– DC plans are top-heavy when the aggregate account balances of key employees exceed 60 percent of the total account balances as of the determination date

53

IRC §416

• Top-heavy determination date– For a new plan, the last day of the first plan year

– For an existing plan, the last day of the preceding plan year

54

IRC §416

• A key employee is an employee who at any time during the determination year was: – An owner of more than five percent;

– An owner of more than one percent with annual compensation in

excess of $150,000; or

– An officer with annual compensation exceeding $130,000, adjusted for cost of living ($175,000 in 2017)• To be an officer, an employee does not need the title of an officer, but rather has

the same authority as an officer (duties, term of position, extent of authority)

• The number of officers who can be considered key employees is limited to the greater of:

– Ten percent of the total number of employees, subject to a maximum of 50 officers; or

– Three officers

55



Spouse Spouse

Parent Child



Grandparent None

Sibling None

56

IRC §416

• IRC §416(b) requires top-heavy plans to provide more rapid vesting:– 100 percent after three years of service (“three-year cliff”); or

– 20 percent after two years of service, increasing 20 percent each subsequent year until 100 percent after six years (“six-year graded”)

57

IRC §416

• Top-heavy minimum benefit in a DB plan – Must be provided to anyone who worked ≥ 1,000 hours; no last day

requirement

– Minimum benefit = two percent of (five-year) average compensation times years of service with the employer (not to exceed ten)

• Top-heavy minimum benefit in a DC plan – Must be provided to anyone who worked on the last day of the plan

year; no hours requirement

– If employee is eligible for any portion of the plan (e.g., immediate 401(k) deferrals), then he or she is eligible for the top-heavy minimum• Includes employees who are eligible for elective deferrals but don’t make them

– Minimum allocation = three percent of §415(c)(3) compensation (or lower percentage if highest key employee is under three percent)

58

CASH BALANCE PLANS

59

Cash Balance Plans

• Most new small plans (other than owner-only plans) are cash balance plans

• Why design a cash balance plan over a traditional defined benefit plan?– A CB plan is easier to understand than a traditional DB plans

• CB benefits are determined as a lump sum

• Traditional DB benefits are determined as a life annuity

– It’s easier to design more equitable benefits for multiple owners under a CB plan than a DB plan• Equal pay credit for all owners; or

• Owners receive varying amounts based on age, compensation, and/or other factors

– Lump sums aren’t subject to interest rate swings as in a DB plan

60

IRC §415 Limit

• If our goal is to maximize benefits, we need to understand the benefit limit under Internal Revenue Code §415

• The §415(b) limit for 2017 is $215,000, which is the maximum annual annuity payable from a defined benefit plan at age 62– Prorated for fewer than ten years of participation

– Assumes 100 percent of average compensation limit does not apply

61

IRC §415 Limit – Cash Balance Plan

• The §415 limit determines the maximum CB credit– Take the current year’s §415(b) limit

– Adjust the limit from age 62 to the age of the owner. The age-adjusted dollar limit is the lesser of:• The amount determined actuarially using five percent and the applicable mortality

table; or

• The amount determined using plan factors

– Convert the annuity to a maximum lump sum using the lesser of:• The amount determined actuarially using 5.5 percent and the applicable mortality

table; or

• The amount determined using plan factors

– Take one-tenth of the maximum lump sum, since the §415(b) limit is phased in over ten years of participation

62

IRC §415 Limit – Cash Balance Plan• Example

– Given• Employee age: 50

• Normal Retirement Age: 62

• Compensation: In excess of §401(a)(17) limit each year

• ERF at age 50 using statutory assumptions (5.0 percent, 2017 AMT): 0.45349

• ERF at age 50 using plan’s assumptions (5.0 percent, 94 GAR): 0.44940

• Lump sum factor using statutory assumptions (5.5 percent, 2017 AMT): 181.95513

• Lump sum factor using plan’s assumptions (5.0 percent, 94 GAR): 188.53485

– Maximum CB credit at age 50 = $146,000• 2017 §415 dollar limit: $215,000

• Adjust from age 62 to age 50: $215,000 x MIN(0.45349, 0.44940) = $96,621 annually = $8,051.75 monthly

• Convert to maximum lump sum = $8,051.75 x MIN(181.95513, 188.53485) = $1,465,057

• Take one-tenth of maximum lump sum = $146,506 round down

63

IRC §415 Limit – Cash Balance Plan

• Maximum cash balance credits credits for 2017– Age 40: $88,000

– Age 45: $113,000

– Age 50: $146,000

– Age 55: $188,000

– Age 60: $243,000

• Maximum cash balance credits will differ based on:– Plan’s Normal Retirement Age;

– Plan’s early retirement factors; and/or

– Plan’s definition of actuarial equivalence

64

DB/DC COMBO PLANS

65

Why Combo Plans?

• Why pair a cash balance plan with a 401(k) profit sharing plan, thereby creating a “combo plan”?– Cash balance plan allows for higher contributions at older ages (2017)

• Age 40: DC contribution = $54,000 CB credit = $88,000





– Profit sharing plans have more funding flexibility than cash balance plans

66

Why Combo Plans?

– A cash balance plan substantially benefiting the owner(s) will not pass nondiscrimination testing on a standalone basis

– When a DB plan cannot pass nondiscrimination testing on a standalone basis, permissively aggregate with a profit sharing plan and test on a benefits basis

– For testing purposes, profit sharing contributions provide more valuable benefits than cash balance credits• When testing a CB plan, you project to NRA using the current interest crediting rate

(e.g., five percent)

• When testing a PS plan, you project to testing age using “standard assumptions” (e.g., 8.5 percent)

• A $600 CB credit will provide a smaller benefit at age 65 (projected at five percent) than a $600 PS allocation (projected at 8.5 percent)

67

Why Combo Plans?

Age 30

PS: $600 * (1.085)35 = $10,428

CB: $600 * (1.05)35 = $3,310

Age 65

68

Combined Plan Testing

• For §410(b) and §401(a)(4), multiple plans may be:– Permissively aggregated to pass testing;

– Permissively disaggregated to pass testing; and/or

– Mandatorily disaggregated to pass testing

• Aggregated plans must pass both the Gateway Test and the General Test

69


• Permissive aggregation (§1.410(b)-7(d)) – Plans (or part of plans) must not be mandatorily disaggregated

– Plans must have the same plan year (not just the same plan year end)

– Test as a single plan• Single §410(b) test

• Single §401(a)(4) test

70


• Mandatory disaggregation (§1.410(b)-7(c))– 401(k) plans must be separated from non-401(k) plans

– 401(m) plans must be separated from non-401(m) plans

– ESOPs must be separated from non-ESOPs

– Plans covering employees of a SLOB, if such employees are treated as excludable

– Plans covering union employees must be separated from plans covering non-union employees

– If the plan covers employees of more than one employer (i.e., a multiple employer plan), those different employers are separated

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• For purposes of Average Benefits Percentage Test only, the plan being tested must:– Include 401(k) plans, 401(m) plans, and ESOPs;

– Exclude union plans and plans of other QSLOBs (if doing ABPT within a QSLOB); and

– Use plan years ending in the same calendar year

• IRC §1.410(b)-7(e)

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• Example #1– Employer maintains two plans:

• 401(k) profit sharing plan with December 31 plan year end

• Cash balance plan with June 30 plan year end

– Plans for testing (other than ABPT)• 401(k) plan is disaggregated

• Profit sharing plan and cash balance plan may not be aggregated because they have different plan years

– Plans for testing the ABPT• All plans are aggregated

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• Example #2– Employer maintains two plans:

• EXISTING 401(k) profit sharing plan with December 31 plan year end

• NEW Cash balance plan with December 31 plan year end

– Plans for testing (other than ABPT)• 401(k) plan is disaggregated

• If effective date of cash balance plan is January 1, then plans may be aggregated

• If effective date of cash balance plan is NOT January 1, then plans may not be aggregated because they have different plan years

– Plans for testing the ABPT• All plans are aggregated

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• DC plans may be aggregated with DB plans and tested on a benefits basis if:– The aggregated DB/DC plan is “primarily defined benefit in nature”

(i.e., the percentage of NHCEs benefiting primarily in the defined benefit plan is at least 50 percent);

– The aggregated DB/DC plan consists of “broadly available separate plans” (will likely never use);

– The aggregated DB/DC plan satisfies the minimum aggregate allocation “gateway test”; or

– The lowest NHCE allocation rate based on §415(c) compensation is at least 7.5 percent

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• The Gateway Test is satisfied if:– The highest HCE allocation rate is less than 15 percent and is no more

than three times the lowest NHCE allocation rate;

– The highest HCE allocation rate is 15 to 25 percent, and the lowest NHCE allocation rate is five percent; or

– The highest HCE allocation rate exceeds 25 percent, and the lowest NHCE allocation rate is at least five percent plus one percent for each five percent increment (or portion thereof) that the highest HCE allocation rate exceeds 25 percent

• May use compensation from date of participation

• May use the average Equivalent Allocation Rate of all NHCEs benefiting under the DB plan, rather than using the individual rates of the NHCEs

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• The Gateway Test is summarized as follows:

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If highest HCE allocation rate is:

Then the lowest NHCE allocation rate must be at least:

Less than 15% 1/3 of the highest HCE rate

15% to 25% 5%

25% to 30% 6%

30% to 35% 7%

35% to 40% 8% (but doesn’t need to be more than 7.5% of 415(c) compensation)


• Which NHCEs must get Gateway? – §1.401(a)(4)-9(b)(2)(v)(D) states that each “NHCE” must receive the

applicable minimum

– § 1.401(a)(4)-12 defines a NHCE as “an employee who is not a HCE” (emphasis added)

– §1.401(a)(4)-12 defines “employee” as: With respect to a plan for a given plan year, employee means an employee (within the meaning of section 1.410(b)-9) who benefits as an employee under the plan for the plan year (within the meaning of section 1.410(b)-3). (emphasis added)

– Therefore, each NHCE who receives any DC allocations or any increase in accrued benefit under DB plan must receive Gateway• Three percent non-elective safe harbor contribution

• Top-heavy minimum contribution

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• Profit sharing contributions are now required for NHCEs as long as the CB plan exists

• Owners have flexibility with their profit sharing contributions and 401(k) deferrals

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Combined Plan Top-Heavy Benefits

• Required aggregation group– Each plan in which at least one key employee participates (does not

need to be the same key employee)

– Any plan in which a key employee participates plus any other plan (including one with no key employees) that are permissively aggregated to meet §410 and §401(a)(4)

• Permissive aggregation group– Two or more plans when aggregated would also pass §410 and

§401(a)(4)

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• Top-heavy determination date– For a new plan, the last day of the first plan year

– For an existing plan, the last day of the preceding plan year

– For aggregated plans, determine the present value separately for each plan as of each plan’s determination date and add together• When plan years are the same, use the respective determination date(s)

• When plan years are different, use the determination dates that fall within the plan year

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• If the required aggregation group is top-heavy, then all of the plans in the group are top-heavy

• If a permissive aggregation group is not top-heavy, then all of the plans in the group are considered not top-heavy

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• Treas. Reg. §1.416-1 Q&A M-12 allows four permissible methods of satisfying the top-heavy minimum benefits for combo plans:– Provide DB minimum only;

– Use a floor offset approach, pursuant to Rev Rule 76-259, under which the DB plan provides the top-heavy minimum and is offset by the benefits provided under the DC plan

– Use a comparability analysis, pursuant to Rev Rule 81-202, that the combined plans are providing benefits at least equal to the DB minimum

– Provide a five percent DC allocation used in most combo plans

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Defined Benefit Plan Defined Contribution Plan

Must the participant work ≥ 1,000 hours?

Yes No

Must the participant work on the last day of the plan year?

No Yes

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• Combo plan top-heavy minimum (five percent) must be provided to participants in both plans with ≥ 1,000 hours, whether or not employed at year-end

• DC plan top-heavy minimum (three percent) must be provided to participants who are not subject to the DB minimum, either because they did not benefit in the DB plan (< 1,000 hours) or they are excluded from the DB plan, and employed at year-end

• No top-heavy minimum required for terminated participants with < 1,000 hours

Combined Plan Deduction Limit

• Under §404(a)(7), there is a combined plan maximum deductible contribution– The DB plus employer-provided DC contributions are essentially

limited to 31 percent of compensation

• This limit applies when:– Employer contributes to both a defined benefit plan and a defined

contribution plan for same tax year; and

– At least one employee is a beneficiary in both plans

• This limit does not apply when:– The defined benefit plan is covered by the PBGC;

– The employer-provided DC contribution is not more than six percent of compensation; or

– The plan is a multiemployer plan85


• Deduction is limited to the greater of:– 25 percent of compensation for participants receiving employer-

provided benefits in either the DB or DC plan; or

– The minimum required contribution in the defined benefit plan, treating a contribution that does not exceed the unfunded current liability (i.e., funding target minus actuarial value of assets) as an amount necessary to satisfy the minimum funding standard

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• Notice 2007-28 Q&A 8– If employer-provided DC contributions exceed six percent of

compensation, only DC contributions over six percent are considered in determining the 25 percent limit

– Effectively translates to a 31 percent limit

– BUT, only consider compensation for participants receiving employer-provided benefits in the DC plan in determining the six percent limit

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• Example– Eligible compensation = $385,000

– 31 percent of eligible compensation = $119,350

– Employer-provided contributions• Profit sharing (including three percent safe harbor): $44,000

• Cash balance: $126,800

• Total: $170,800

– Test result• If PBGC-covered, then PASS

• If not PBGC-covered, then FAIL– Total contributions are greater than 31 percent of eligible compensation

– Profit sharing contribution is greater than six percent of eligible compensation

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PBGC

• Required coverage for most plans, unless exempt under ERISA 4021

• Plans not covered by the PBGC include:– Plans covering only substantial owners

– Professional service employers with fewer than 26 active participants

• Definitions– A “substantial owner” is an individual who, at any time during the

prior 60 months, owns:• The entire interest in a sole proprietorship;

• More than ten percent of either a capital or profits interest in a partnership; or

• More than percenty in value of either the voting or all stock of a corporation

• Note that family attribution rules under IRC § § 1563 and 414(c) – the rules for controlled group family attribution – apply

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PBGC

• Definitions (continued)– “Professional service employer” means any proprietorship,

partnership, corporation, or other association or organization owned or controlled by professional individuals and the business is to perform professional services

– “Professional individuals” include, but are not limited to, physicians, dentists, chiropractors, osteopaths, optometrists, other licensed practitioners of the healing arts, attorneys at law, public accountants, public engineers, architects, draftsmen, actuaries, psychologists, social or physical scientists, and performing artists license requires advanced study

• If the plan is not PBGC-covered, then the combined plan deductible limit under §404(a)(7) applies

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CASE STUDIES

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Case Studies

• In these case studies, we maximize the owner in both the cash balance and profit sharing plans

• Assume the plan is not PBGC-covered, so the combined plan deduction limit applies

• Case Study 1 is an example where the owner is 22.5 years older than the average age of employees

• Case Study 2 is an example where the owner is 12.5 years older than the average age of employees

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Case Study 1

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Employer Contributions

Name Owner HCE Age

Plan

Comp

Profit

Sharing

Cash

Balance Total

Employee

Deferrals Total

Owner Y Y 50 $270,000.00 $15,600.00 $146,000.00 $161,600.00 $24,000.00 $185,600.00

Employee 1 30 $40,000.00 $2,700.00 $500.00 $3,200.00 $0.00 $3,200.00

Employee 2 25 $40,000.00 $2,700.00 $500.00 $3,200.00 $0.00 $3,200.00

Total for Owners $270,000.00 $15,600.00 $146,000.00 $161,600.00 $24,000.00 $185,600.00

Total for Non-Owners $80,000.00 $5,400.00 $1,000.00 $6,400.00 $0.00 $6,400.00

Grand Total $350,000.00 $21,000.00 $147,000.00 $168,000.00 $24,000.00 $192,000.00

• Average age of employees = 27.5

• Cash balance

– $146,000 for owner

– $500 for employees

• 401(k) profit sharing

– $15,600 for owner needed to reduce for §404(a)(7)

– 6.75 percent of compensation for employees needed for Gateway

Case Study 2

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• Average age of employees = 37.5

• Cash balance

– $146,000 for owner

– $700 for employees needed for §401(a)(26)

• 401(k) profit sharing

– $12,600 for owner needed to reduce for §404(a)(7)

– 10.50 percent of compensation for employees needed for Rate Group

Testing

• Employee cost increases from $6,400 to $9,800 when employees are ten years older

Employer Contributions

Name Owner HCE Age

Plan

Comp

Profit

Sharing

Cash

Balance Total

Employee

Deferrals Total

Owner Y Y 50 $270,000.00 $12,600.00 $146,000.00 $158,600.00 $24,000.00 $182,600.00

Employee 1 40 $40,000.00 $4,200.00 $700.00 $4,900.00 $0.00 $4,900.00

Employee 2 35 $40,000.00 $4,200.00 $700.00 $4,900.00 $0.00 $4,900.00

Total for Owners $270,000.00 $12,600.00 $146,000.00 $158,600.00 $24,000.00 $182,600.00

Total for Non-Owners $80,000.00 $8,400.00 $1,400.00 $9,800.00 $0.00 $9,800.00

Grand Total $350,000.00 $21,000.00 $147,400.00 $168,400.00 $24,000.00 $192,400.00

Questions?

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Large Versus Small DB Plans: A Comparison for DB Practitioners€¦ · • Physicians • Dentists • Certified Public Accountants ... employment tax) –Reduce for retirement plan