Retirement plans

     Although April 15th was weeks ago, the impact of paying income taxes may still have a lingering affect for many people. Many of these same people are high income professionals and business owners who find themselves with a retirement plan dilemma. They have high earnings but inadequate retirement savings, due to limits on 401(k) tax-deferred savings and also because they have invested heavily in building their business or professional service practice. 

If you happen to find yourself in this situation, and would also like a significant tax deduction, adding a Cash Balance Plan may be the perfect solution. Cash Balance Plans provide participants with an annual pre-tax contribution limit of up to $275,000, typically double or even triple what is allowed in a 401(k) profit sharing plan ($59,000 if age 50 or older). 

Tax-qualified retirement plans are broadly divided into two categories: 1) defined contribution plans, like a 401(k) plan and, 2) defined benefit plans, like a traditional pension plan. If you have a 401(k) plan you can contribute up to $24,000 if 50 years or older and $18,000 if less than age 50. When a profit sharing plan is added another $35,000 can be contributed. Once you have reached the combined annual maximum contribution of $59,000 then no further contributions are permitted, which simply may not be enough to fund a retirement these days. 

Since these contributions are tax deductible it may be possible to accumulate a retirement benefit of more than $2.6 million over 10 years. If income tax rates rise in the future this tax deferral feature becomes more attractive. In addition, if someone who is 50 years of age today and participates in all three retirement plans may be able to defer in excess of $3.5 million without consideration of investment growth potential. 

     The Cash Balance Plan is deemed as a hybrid retirement plan since it takes on characteristics from both the defined contribution and defined benefit plans. Each participant has an individual or hypothetical account similar to a 401(k) plan. Employers make contributions to each participant’s account with annual pay credits (contribution) and interest credits (typically around 5%). 

     Furthermore, unlike a 401(k) plan the participant does not have any investment risk. The nature of Cash Balance plans and the investment structure typically insulates them from market volatility. The investment goal for a Cash Balance Plan is to protect the tax deduction rather than maximize investment returns. The investment goal for the investment manager is to optimize the returns by meeting the interest credit rate each year. 

When paired with a 401(k)/profit sharing plan, the two plans are combined for nondiscrimination testing. The Cash Balance Plan combination arrangement allows maximization of benefits to owners and other “key” participants while keeping employee contribution costs relatively low. Contributions can be a percentage of salary or a flat dollar amount and are stated in the plan document. 

     Cash Balance Plans are “defined benefit” plans. Therefore, the contributions and interest credits are NOT discretionary and an actuary provides the funding requirement to the plan sponsor. Employers can designate different contribution amounts for various participants which allows for greater flexibility. Once participants retire or terminate employment, they are eligible to receive the vested portion of their account balance. In addition, Cash Balance Plan accounts are portable and can be rolled over to an IRA. 

Generally, Cash Balance Plans are an ideal retirement plan for business owners and professional service practices where the following exist: 

· Partners and/or owners with annual income exceeding $250,000, 

· Partners and/or owners who want to contribute $50,000 or more above and beyond their 401(k) plan contribution, 

· Achieve a relatively steady cash flow, and; 

· A willingness to contribute up to or greater than 5% of pay to employee retirement plans. 

Cash Balance Plans are relatively easy to create and manage. Professional service practices (fields of accounting, law, medicine or dentistry) that are profitable and are seeking tax deductions will find the Cash Balance Plan an extremely attractive retirement plan vehicle. Another attraction is the defined benefit plan is protected from their creditors. In today’s litigious society, a Cash Balance plan can be used to protect doctor’s assets. 

Another attraction is that the business’s defined benefit plan is protected from their creditors. In today’s litigious society a Cash Balance Plan can be used to protect owners and partners’ assets. Keep in mind that a Cash Balance Plan must be established by December 31st to take advantage of tax deduction in 2015, although the plan does not need to be funded until the firm’s tax return is due. 

     Finally if concerns exist about the amount of taxes you’ll have to pay or the volatility of your retirement plan portfolio or maybe that you are late to the game in saving for retirement, consider the addition of a Cash Balance Plan for your professional practice. 

The combination of an existing or start-up 401(k) and profit sharing plan with a Cash Balance Plan can provide significant opportunity to reduce taxable income, be a great wealth accumulation vehicle and be a more powerful means for securing the retirement of professionals and business owners alike.

     It’s been more than two years since the Dept. of Labor (DoL) instituted the retirement plan disclosure regulations requiring plan sponsors to be transparent regarding all fees related to the administration of their company retirement plan or 401(k) plan. 

     All plan sponsors have a fiduciary duty to disclose this information to all their plan participants. There are far too many plan sponsors that are not meeting these requirements. Although they are not looking for trouble they are likely to find it. 

     Plan sponsors have another fiduciary duty, which is to determine whether the fees they pay to their plan providers are reasonable. The only way to determine this is to have those fees benchmarked through a certified service that compares fees from other plan providers. Plan sponsors must insure that the retirement plan fees incurred by their retirement plan or 401k plan are reasonable. 

The best way to accomplish compliance with this regulation is to conduct an annual plan review. 

Typical responses I have encountered when requesting a plan review: 

1. 'Our plan is too small' 

2. 'Our plan provider reviews our plan'

3. 'Our attorney reviewed our plan’

4. 'A plan review is too expensive’ 

Let’s look at each of these responses. 

1. ‘Our plan is too small.’ The IRS and the DoL can care less about the size of a retirement plan. They each have hired countless auditors and are auditing poorly administered retirement plans. The IRS is most concerned with retirement plans meeting qualifications under the Internal Revenue Code. The DoL wants to make sure that plan participants rights are being met under ERISA. Due to the fee disclosure regulations, the DoL audits are on the rise. 

Whether a plan sponsor is subjected to an IRS or DoL audit, neither is pleasant and each would be costly. Most importantly, it is not a question of if a plan sponsor will be audited but rather a question of when an audit will occur. 

2. ‘Our plan provider reviewed our plan.’ A favorite response is that the plan provider reviewed our plan and told me our plan is good. It is not unusual that plan sponsors are told by their plan providers that their plan is “good.” This response begs a few questions. What does that mean? What type of analysis was performed? How was the decision arrived at? Is it an opinion of the plan provider? If so, isn’t this opinion inherent with conflict of interest? 

3. ‘Our attorney reviewed our plan.’ When a plan sponsor states that their attorney reviewed their retirement plan and discovered no risks, that’s a red flag. Once again this response begs a few questions. What relationship does that plan sponsor have to the attorney? Is he employed by the company as general counsel? Does he understand ERISA? If he is a non-ERISA attorney we can liken this to going to see a neurologist for a sprained ankle. This approach may be dangerous to the health and well- being of the retirement plan and even the plan sponsor. 

4. ‘A plan review is too expensive.’ A plan review can take on several different forms. Therefore, although a plan sponsor may balk at the thought of spending money on an annual review (we recommend at least an annual and in some cases semi-annual reviews) they are not as expensive as you may think. Some advisors offer a nominal charge for a plan review. Others offer a free review of a retirement plan’s investment options. 

     The cost of a plan review must be measured against the liability that would be avoided. An annual review should be performed much like an annual visit to your doctor for a physical or a routine dental checkup. The plan review will help to preserve the financial health of the plan’s retirement assets and avoid a breach of the plan sponsor’s fiduciary duty. Plan reviews should be performed at least annually to insure that the needs of the business and the plan participants continue to be met and monitored to adjust to any changes that may occur.