Defined Benefit Plan at small company

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Fictionme
Posts: 24
Joined: Thu Jan 25, 2018 10:06 am

Defined Benefit Plan at small company

Post by Fictionme »

My company is the process of resuming our defined benefit plan (contributions were frozen last year in the middle of the pandemic). I believe the plan restricts how much we can contribute based on age. Some of the more senior shareholders are looking forward to being able to contribute large sums of money, 100-150k. The more junior shareholders, having the burdens of young families/more expenses, are less inclined to contribute as much (and also it seems they cannot even if they wanted).

As I understand these plans there is a targeted growth rate of about 4%, any excess can be saved in the the event of a shortfall. If there isn’t enough then the shareholders must make up the difference. The company is in effect guaranteeing the fund. Does that make sense given that everyone has different amounts of money invested? What would be the incentive of a plan like this if you were 20+ years away from retirement? Would you be better off paying the taxes upfront and investing in a more aggressive manner given the longer time horizon?

From my readings on DB/cash balance plans, it seems they work best when all shareholders have near equal amounts of money invested? Has anyone been able to structure their plan so as to make sure that if a shortfall develops that those individuals contribute in proportion to how much they have invested already?

What about keeping the plan open for 8-10years, then closing it? The shorter window would allow everyone to roll it out into an IRA and then manage the money in whatever investments they want. We could then start a new plan after that and start the process again.

I am still struggling with the asymmetric liability inherent in these plans in the event of a shortfall. I am also having trouble deciding if the tax deferral (even at the highest tax bracket) is worth investing in a less aggressive manner. What are your experiences with these types of plans? For those who have participated in these types of plans what surprises have developed?
ralph124cf
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Re: Defined Benefit Plan at small company

Post by ralph124cf »

This sounds like a very strange "defined benefit" plan. As a general rule, "shareholders" are not entitled to a retirement plan, only workers who get W-2s.

What are the rules for payout at retirement?

Ralph
humblecoder
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Re: Defined Benefit Plan at small company

Post by humblecoder »

I agree that the plan that you are describing sounds very strange. Maybe it is just the terminology that you are using which is causing the confusion. Not sure.

What you describes sounds like it could be some sort of defined benefit plan. However, It doesn't sounds like a cash balance plan since it sounds like all of the money gets pooled together towards the funding of some guaranteed payout. But it doesn't sound like a traditional pension since each person can make some sort of discretionary contribution. You are also using the terms "shareholders" rather than "employees", so that is also adding to the confusion.

So basically either this is some strange plan that is very uncommon or you are completely misunderstanding that structure of the plan. In either case, you are likely not going to get any intelligent or useful answers based upon what you have described (at least without some further clarifications).
SmartStructure
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Joined: Mon May 03, 2021 11:53 am

Re: Defined Benefit Plan at small company

Post by SmartStructure »

Just an FYI, the specific wording that you use to describe your plan means quite a lot, but I believe this is your situation.

A small company DB plan will greatly benefit a small, profitable company where the owners or key people are older than the rest of the employees. A DB plan defines what comes out of the plan (the benefit) not what goes into the account (the contribution). Plan contributions are made by the company. When the plan structure works, the older employees will receive a very large contribution relative to the younger employees. Think how much a 60 year old trying to save for a benefit payout in 5 years vs a 25 year old saving for 40 years. I’ve handled plans where the plan contribution was $500k and the owner of the business received 80% of the contribution, the key employee received 10% and the balance was split amongst 3 lower level employees. It worked like a charm.

Because of the affect that age and income have on the calculations, you don’t see these plans too often these days. The larger the employee pool, the higher the cost and worse the risk for th business owner.
Topic Author
Fictionme
Posts: 24
Joined: Thu Jan 25, 2018 10:06 am

Re: Defined Benefit Plan at small company

Post by Fictionme »

That plan you described sounded like it worked very well for the business owner, who took home 80% of the contribution. What about all the other employees that contributed to it? Sounds like it was just another way for the owner to fleece the company on the way out, unless he/she contributed that 'defined benefit" in pre-tax dollars. Do you think that plan would have worked if all the employees were "equal" owners? Would anything be left for an employee that is 35 years old?


In my head this makes sense if you are in a high tax bracket, then pull it out at a lower tax level....but only towards the end of your career when you are not in need of aggressive growth for your investments
cdc
Posts: 95
Joined: Fri Jun 02, 2017 1:05 pm

Re: Defined Benefit Plan at small company

Post by cdc »

Fictionme wrote: Sun May 02, 2021 8:58 am My company is the process of resuming our defined benefit plan (contributions were frozen last year in the middle of the pandemic). I believe the plan restricts how much we can contribute based on age. Some of the more senior shareholders are looking forward to being able to contribute large sums of money, 100-150k. The more junior shareholders, having the burdens of young families/more expenses, are less inclined to contribute as much (and also it seems they cannot even if they wanted).

As I understand these plans there is a targeted growth rate of about 4%, any excess can be saved in the the event of a shortfall. If there isn’t enough then the shareholders must make up the difference. The company is in effect guaranteeing the fund. Does that make sense given that everyone has different amounts of money invested? What would be the incentive of a plan like this if you were 20+ years away from retirement? Would you be better off paying the taxes upfront and investing in a more aggressive manner given the longer time horizon?

From my readings on DB/cash balance plans, it seems they work best when all shareholders have near equal amounts of money invested? Has anyone been able to structure their plan so as to make sure that if a shortfall develops that those individuals contribute in proportion to how much they have invested already?

What about keeping the plan open for 8-10years, then closing it? The shorter window would allow everyone to roll it out into an IRA and then manage the money in whatever investments they want. We could then start a new plan after that and start the process again.

I am still struggling with the asymmetric liability inherent in these plans in the event of a shortfall. I am also having trouble deciding if the tax deferral (even at the highest tax bracket) is worth investing in a less aggressive manner. What are your experiences with these types of plans? For those who have participated in these types of plans what surprises have developed?
Is the plan only open to shareholders? This does not sound like a DB plan. Do you have a plan document that explains the plan and how benefits are calculated? Do you receive an annual funding notice?
water2357
Posts: 95
Joined: Sat Sep 12, 2020 9:24 am

Re: Defined Benefit Plan at small company

Post by water2357 »

What is the company structure? You keep mentioning shareholders. Is this company incorporated? Or is it some type of partnership?

Defined benefit plans are governed by ERISA, there are required employer contributions each year depending on the funding of the plan. The only way individual employees would get stuck making up some type of shortfall of funding is if the employees are also the owners of the company and still the shortfall would come out of company monies, not exactly the same as the owners.

So, how is the company structured? Are you an owner? Are you responsible for company debts?
Topic Author
Fictionme
Posts: 24
Joined: Thu Jan 25, 2018 10:06 am

Re: Defined Benefit Plan at small company

Post by Fictionme »

plan is only open to shareholders

all shareholders are equal owners, just span the age range from 30's -60's

There are fewer employees than shareholders, but there is a small funding that is contributed by shareholders on behalf of employees
water2357
Posts: 95
Joined: Sat Sep 12, 2020 9:24 am

Re: Defined Benefit Plan at small company

Post by water2357 »

Fictionme wrote: Mon May 03, 2021 9:53 pm plan is only open to shareholders

all shareholders are equal owners, just span the age range from 30's -60's

There are fewer employees than shareholders, but there is a small funding that is contributed by shareholders on behalf of employees
Unless all the "employees" own this company, have not heard of the IRS (Depts of Treasury and Labor) allowing a defined benefit plan that only benefits owners and does not benefit employee/nonowners (how does it pass the discrimination tests?). Possibly this is some type of a "deferred compensation plan" but it doesn't appear that is can be a defined benefit plan under ERISA.

However, the last sentence seems to contradict the first sentence. This seems to state that some employees, who are not shareholders, are participants in the plan. And that the shareholders/owners do contribute to fund the benefits provided to the employee/nonshareholder/nonowner participants. So, it's hard to tell what this is without reading the plan document.

If this is a defined benefit plan governed by ERISA, find out who the plan administrator is and ask them for a copy of the plan document and the latest SPD (Summary Plan Description) and SMM (Summary of Material Modifications). If you can't get copies from the plan administrator, go to the Department of Labor web site and request them there. Until you know exactly what kind of plan you have, and the rules of that plan, there is no way to answer.
SmartStructure
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Joined: Mon May 03, 2021 11:53 am

Re: Defined Benefit Plan at small company

Post by SmartStructure »

Fictionme wrote: Mon May 03, 2021 7:33 pm That plan you described sounded like it worked very well for the business owner, who took home 80% of the contribution. What about all the other employees that contributed to it? Sounds like it was just another way for the owner to fleece the company on the way out, unless he/she contributed that 'defined benefit" in pre-tax dollars. Do you think that plan would have worked if all the employees were "equal" owners? Would anything be left for an employee that is 35 years old?


In my head this makes sense if you are in a high tax bracket, then pull it out at a lower tax level....but only towards the end of your career when you are not in need of aggressive growth for your investments
Remember, the employee makes no contribution, the owner makes all contributions. Equal owners doesn’t mean similar age or similar desires or goals. The value of this plan is simply a math test. This means there is no payroll deferral. There is always a benefit for the younger employee as the plan MUST pay him out, at retirement, as per the benefit design. If the plan has enough cash in it currently, the owner can elect to close the plan by buying a guaranteed vehicle to deliver the benefit (traditionally an annuity) or let the employee take their lump sum benefit and roll it elsewhere.

This type of plan is only practical when the employee census works in owners favor OR if the owner is very patriarchal and wants to fund his employees retirement.
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LadyGeek
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Re: Defined Benefit Plan at small company

Post by LadyGeek »

This thread is now in the Personal Finance (Not Investing) forum (defined benefit plan questions).

Fictionme - You have a previous thread: severance/buyout structure (Oct 06, 2020)

Perhaps a few focused questions can help here.

- What, exactly, would you like to know about this plan?

- What will you do with this information with regards to your personal retirement planning or with your investments?
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
coalcracker
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Joined: Sat Feb 04, 2012 12:25 pm

Re: Defined Benefit Plan at small company

Post by coalcracker »

This sounds like a cash balance plan:

https://www.whitecoatinvestor.com/cash ... essionals/

Our medical practice (20 physician owners and 6 employees) had one of these in the past, since closed.

Long story short: it’s complicated, but may be worth it if you want/need to defer large amounts of taxable income. A good plan administrator is key.

Edited:
What about keeping the plan open for 8-10years, then closing it?
Many plans, as I understand, do exactly this. Ours closed after about a decade but we didn’t open a new one due to lack of interest.
ModifiedDuration
Posts: 308
Joined: Sat Dec 05, 2015 4:33 pm

Re: Defined Benefit Plan at small company

Post by ModifiedDuration »

coalcracker wrote: Thu May 06, 2021 6:46 pm This sounds like a cash balance plan:

https://www.whitecoatinvestor.com/cash ... essionals/

Our medical practice (20 physician owners and 6 employees) had one of these in the past, since closed.

Long story short: it’s complicated, but may be worth it if you want/need to defer large amounts of taxable income. A good plan administrator is key.

Edited:
What about keeping the plan open for 8-10years, then closing it?
Many plans, as I understand, do exactly this. Ours closed after about a decade but we didn’t open a new one due to lack of interest.
Yeah, it definitely sounds like a cash balance defined benefit plan.
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