Top Hat DB Cash Balance Plan on top of 401K?

[JamesSFO]

We're a small (2 person) law firm looking at what else we could tax defer beyond the $51K for 2013 in a (solo) 401K.

One of the people we were talking with suggested adding a "Cash Balance Defined Benefit Plan" on top of the (solo) 401K, looks like at the max it could let us defer an additional $45K (401K employee contribution - $17.5K, 401K employer contribution - $33.5K, defined benefit cash balance contribution, $45.5K = $96.5K total deferred)

It sounds like we would have a single combined "trust" account that we could direct the investment of (say into VG Total Stock, etc.).

What I'm not understanding (yet) are the downsides in terms of what if we want to stop the plan, what if one of us quits, the firm dissolves, etc.

Anyone have experience with these? What questions should I be asking?

[JamesSFO]

Just going to bump this, I know there are folks here who know about this and was hoping to hear some of the gotchas...

[dhodson]

It is possible to have both a defined benefit plan and defined contribution. Defined contribution is your 401k or profit sharing. You only allowed to put a specific amount in each year but they can grow to whatever. Defined benefit is such that they are designed to provide you a pension at retirement meaning x dollars per year up to around 200k. The amount you put into each plan per year depends on your age and current account value. An actuary decides a range for you. Defined benefit plans cost more. You also must put the amount in per year. If you don't keep the plan at least 5 years, the IRS likely wont be happy. Thus they are more costly and less flexible. The situation works best the older you are and the fewer employees you have. A db plan will also modify your dc allowable contribution.

[allocator]

Hi. I was just on the board last night asking for help with a related issue: viewtopic.php?f=1&t=110912

A number of issues to consider. My understanding is that the beneficiaries/owners (you and your partner) cannot manage the funds. It is definitely NOT a self-directed 401k. There are very specific minimum and maximum annual contributions you are committing to, but these may fluctuate from year to year depending on the performance of the plan. Here is the clearest explication of CBPs I've seen: https://www.bernstein.com/CmsObjectPC/p ... nce_BB.pdf

I think if you are in a higher tax bracket, the pre-tax contribution is difficult to refuse, even with the limitations of these plans.

Good luck. Post or PM if you'd like to compare notes.

[dhodson]

Hi. I was just on the board last night asking for help with a related issue: viewtopic.php?f=1&t=110912

A number of issues to consider. My understanding is that the beneficiaries/owners (you and your partner) cannot manage the funds. It is definitely NOT a self-directed 401k. There are very specific minimum and maximum annual contributions you are committing to, but these may fluctuate from year to year depending on the performance of the plan. Here is the clearest explication of CBPs I've seen: https://www.bernstein.com/CmsObjectPC/p ... nce_BB.pdf

I think if you are in a higher tax bracket, the pre-tax contribution is difficult to refuse, even with the limitations of these plans.

Good luck. Post or PM if you'd like to compare notes.

i manage the funds in my own DB plan and am not aware of any regulation that says you cant.

[JamesSFO]

Hi. I was just on the board last night asking for help with a related issue: viewtopic.php?f=1&t=110912

A number of issues to consider. My understanding is that the beneficiaries/owners (you and your partner) cannot manage the funds. It is definitely NOT a self-directed 401k. There are very specific minimum and maximum annual contributions you are committing to, but these may fluctuate from year to year depending on the performance of the plan. Here is the clearest explication of CBPs I've seen: https://www.bernstein.com/CmsObjectPC/p ... nce_BB.pdf

I think if you are in a higher tax bracket, the pre-tax contribution is difficult to refuse, even with the limitations of these plans.

Good luck. Post or PM if you'd like to compare notes.

Thanks!

[JamesSFO]

It is possible to have both a defined benefit plan and defined contribution. Defined contribution is your 401k or profit sharing. You only allowed to put a specific amount in each year but they can grow to whatever. Defined benefit is such that they are designed to provide you a pension at retirement meaning x dollars per year up to around 200k. The amount you put into each plan per year depends on your age and current account value. An actuary decides a range for you. Defined benefit plans cost more. You also must put the amount in per year. If you don't keep the plan at least 5 years, the IRS likely wont be happy. Thus they are more costly and less flexible. The situation works best the older you are and the fewer employees you have. A db plan will also modify your dc allowable contribution.

Thanks!

[allocator]

Hi. I was just on the board last night asking for help with a related issue: viewtopic.php?f=1&t=110912

A number of issues to consider. My understanding is that the beneficiaries/owners (you and your partner) cannot manage the funds. It is definitely NOT a self-directed 401k. There are very specific minimum and maximum annual contributions you are committing to, but these may fluctuate from year to year depending on the performance of the plan. Here is the clearest explication of CBPs I've seen: https://www.bernstein.com/CmsObjectPC/p ... nce_BB.pdf

I think if you are in a higher tax bracket, the pre-tax contribution is difficult to refuse, even with the limitations of these plans.

Good luck. Post or PM if you'd like to compare notes.

i manage the funds in my own DB plan and am not aware of any regulation that says you cant.

Sorry - I wasn't clear. My understanding is that participants in the plan cannot manage their own accounts as, technically, there are no "individual" accounts. That is, the funds in the plan are pooled and managed as such. So, for example, you wouldn't be able to log on to your account and trade stocks or rebalance your own individual account (like in a 401k).

Collars and credited interest calculations and determinations aside, we decided to participate because of the pre-tax contribution. Hope that helps.

[Mr401k]

Having been a pension consultant to small and medium sized businesses for 37 years, here is my opinion on the opportunity being presented to you. Great idea! Adding a Cash Balance Plan to your 401(k) plan allows you to go substantially beyond the normal $51,000 limit of a Solo-K. The $17,500 of salary deferrals, plus the $33,500 of 401(k) Profit Sharing plus the $45,500 of Cash Balance all looks to be properly done in order to stay within the deductible limit for a Cash Balance Plan that is NOT subject to PBGC coverage. The Profit Sharing of $33,500 plus the Cash Balance of $45,500 or total for those two employer contributions of $79,000 is right at the 31% limit of $255,000 (the most compensation that can be taken into account for a retirement plan for 2013). Seems you have connected with a firm that knows what they are doing.

You will have to restate or amend your Vanguard Solo-K document into a regular 401(k) so that the document has the necessary language to properly coordinate with the new Cash Balance Plan. I am sure your advisors can provide that new 401(k) document for you as they also write your new Cash Balance Plan.

With respect to concerns about being locked-in to something, all you need to do is properly communicate with your TPA and let them know before you have incurred 1,000 hours in a new year that you do not want the same level of funding ($45,500). Not only that, but the Profit Sharing portion of the 401(k) is very, very flexible as well, so you really have a lot of flexibility to respond to some business financial crisis. With the downside being minimal and flexible, it is very worthwhile to go for the upside of doing this. As you know, high income earners are going to be more and more targeted for higher taxes. Being in California, your tax situation is even more affected, so completely deferring taxation of another $45,500 for each of the two of you is terrific.

When you do have eligible support staff, you will need to provide them with a 3% Safe Harbor plus probably an additional 4.5% PS in the 401(k) and perhaps some minimal amount of promise in the Cash Balance.

You can keep your current Solo-K investments at Vanguard and continue to add to them under the new 401(k) document your TPA will provide. The Cash Balance Plan does need to be invested in a "pool" - you and your partner cannot individually direct your Cash Balance accounts, however the two of your will be the Plan Trustees and you will pick the investments yourselves in that capacity. You need to approach the investing for the Cash Balance pool by picking investments (Vanguard mutual funds or ETF's being a Booglehead) that are not overly risky and perhaps can achieve approximately a 5% rate of return over time, since that is the amount that will be credited to your individual hypothetical accounts in the Cash Balance Plan.

Hope that helps - looks like you are making a great move.

[Default User BR]

i manage the funds in my own DB plan and am not aware of any regulation that says you cant.

What kind of plan? According to the definitions the IRS has:

Defined Benefit Plan – This type of plan, also known as a traditional pension plan, promises the participant a specified monthly benefit at retirement. Often, the benefit is based on factors such as the participant’s salary, age and the number of years he or she worked for the employer. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service.

What would be the point of managing the investments?


Brian

[JamesSFO]

Having been a pension consultant to small and medium sized businesses for 37 years, here is my opinion on the opportunity being presented to you. Great idea! Adding a Cash Balance Plan to your 401(k) plan allows you to go substantially beyond the normal $51,000 limit of a Solo-K. The $17,500 of salary deferrals, plus the $33,500 of 401(k) Profit Sharing plus the $45,500 of Cash Balance all looks to be properly done in order to stay within the deductible limit for a Cash Balance Plan that is NOT subject to PBGC coverage. The Profit Sharing of $33,500 plus the Cash Balance of $45,500 or total for those two employer contributions of $79,000 is right at the 31% limit of $255,000 (the most compensation that can be taken into account for a retirement plan for 2013). Seems you have connected with a firm that knows what they are doing.

You will have to restate or amend your Vanguard Solo-K document into a regular 401(k) so that the document has the necessary language to properly coordinate with the new Cash Balance Plan. I am sure your advisors can provide that new 401(k) document for you as they also write your new Cash Balance Plan.

With respect to concerns about being locked-in to something, all you need to do is properly communicate with your TPA and let them know before you have incurred 1,000 hours in a new year that you do not want the same level of funding ($45,500). Not only that, but the Profit Sharing portion of the 401(k) is very, very flexible as well, so you really have a lot of flexibility to respond to some business financial crisis. With the downside being minimal and flexible, it is very worthwhile to go for the upside of doing this. As you know, high income earners are going to be more and more targeted for higher taxes. Being in California, your tax situation is even more affected, so completely deferring taxation of another $45,500 for each of the two of you is terrific.

When you do have eligible support staff, you will need to provide them with a 3% Safe Harbor plus probably an additional 4.5% PS in the 401(k) and perhaps some minimal amount of promise in the Cash Balance.

You can keep your current Solo-K investments at Vanguard and continue to add to them under the new 401(k) document your TPA will provide. The Cash Balance Plan does need to be invested in a "pool" - you and your partner cannot individually direct your Cash Balance accounts, however the two of your will be the Plan Trustees and you will pick the investments yourselves in that capacity. You need to approach the investing for the Cash Balance pool by picking investments (Vanguard mutual funds or ETF's being a Booglehead) that are not overly risky and perhaps can achieve approximately a 5% rate of return over time, since that is the amount that will be credited to your individual hypothetical accounts in the Cash Balance Plan.

Hope that helps - looks like you are making a great move.

Thank you! this was most helpful, I was pretty impressed with the team we talked to, need to get them to pair me with a better record keeper/fund company than I entered with. Great Western contact introduced me to them to be the TPA, but they are independent and I'm not willing to pay the GW ER's on everything.

They did provide the same specifics you mentioned about amending and coordinating.

[JamesSFO]

What would be the point of managing the investments?

I assume what he means (well what _I_ mean) is for a small DB plan with only 1-2 people you are basically investing for yourself, so you can pick a blend of Vanguard funds expected to provide a 4-5% return rather than some (expletive) high ER fund that a financial advisor is shoving down your throat.

[EmergDoc]

My partnership does this but due to actuarial reasons can only put $15K into the DBP and $51K into the 401K/profit-sharing plan. 2012 was my first year contributing and I'm still trying to figure out how to claim it on my taxes. I guess you just stick it on line 28 of the 1040, but Turbotax doesn't seem designed to be able to handle it.

[BruceM]

What would be the point of managing the investments?


Brian

In a private pension plan, each year the employer MUST make a contribution to the plan. Poor investment performace will make the actuarial present value smaller than it should be (underfunded), meaning the employer will have to make a greater contribution to bring the plan up to its current funding requirement.

But to the OP, this is a complicated arena in which only those who do this stuff for a living should venture. Nothing wrong with understanding the basic mechanics, but when your pension plan is at or near the maximum defined benefit and you wish to also make the full allowable contribution to your defined contribution plan, you are going to start getting into fairly large numbers in a few years and mistakes will prove to be costly. The rules here are numerous and funding requirements strict. Now, if you've got the cash flow and wish to shelter income from State + Fed tax, this can be a great way to do it. But it is expensive (figure 4 to 8% at start up and 1 - 2% per year ongoing) and you're going to need the CBP going for at least 10 years (there may be a penalty for plans discontinued prematurely). You might want to get a bid from a couple of the pension plan specialists like Towers-Watson or Mercer for comparison. Both of these typically have offices in the larger cities.

BruceM

[JamesSFO]

In a private pension plan, each year the employer MUST make a contribution to the plan. Poor investment performace will make the actuarial present value smaller than it should be (underfunded), meaning the employer will have to make a greater contribution to bring the plan up to its current funding requirement.

But to the OP, this is a complicated arena in which only those who do this stuff for a living should venture. Nothing wrong with understanding the basic mechanics, but when your pension plan is at or near the maximum defined benefit and you wish to also make the full allowable contribution to your defined contribution plan, you are going to start getting into fairly large numbers in a few years and mistakes will prove to be costly. The rules here are numerous and funding requirements strict. Now, if you've got the cash flow and wish to shelter income from State + Fed tax, this can be a great way to do it. But it is expensive (figure 4 to 8% at start up and 1 - 2% per year ongoing) and you're going to need the CBP going for at least 10 years (there may be a penalty for plans discontinued prematurely). You might want to get a bid from a couple of the pension plan specialists like Towers-Watson or Mercer for comparison. Both of these typically have offices in the larger cities.

BruceM

Thanks Bruce, after April 15 I'm planning to sit down with our firm's CPA and get some more insights as well from them.