Intro
The U.S. faces a pension crisis of epic proportions. Today all "defined benefit pension plans" are underfunded to the tune of $450 billion. In an attempt to address the defined benefit pension crisis, Congress passed and made permanent a law on August 2006 known as the 2006 Pension Protection Act.
The new law is designed to protect not only workers, but also the Pension Benefit Guarantee Corporation (PBGC), the pension provider of last resort that has to step in when companies renege on their promises. The PBGC is a federal entity that is ultimately financed by taxpayers. If enough companies fail to fund their pensions, the potential bailout could make the savings and loan debacle look like pocket change.
In an attempt to relieve the burden on the PBGC, the law of unintended consequences has forced stringent fully funded requirements to maintain a compliant pension for the small to medium plan owner, which the IRS defines as 100 or fewer participants.
Important Changes
The 2006 Pension Protection Act (PPA) has significantly changed the landscape of retirement planning for business owners in America today. Here are a few examples:
- A defined benefit and 401(k)/profit sharing plan can now both be sponsored by the plan owner.
- All defined benefit plans must be fully-funded.
- Cash balance plans are made legal.
- Fully-insured defined benefit plans are established as having the most notable exceptions to the rigid funding rules.
- Beginning in 2008 a defined benefit plan sponsor may contribute and deduct up to 150% of the current plan liability.
- Effective in 2008 there is a single actuarial method for computing the minimum required contribution for defined benefit pensions.
- Comparability testing is now allowed for optimal plan design.
- 40% of all eligible participants must be included in the pension plan.
A major benefit of the 2006 PPA is that it now allows plan sponsors to contribute significantly larger pre-tax dollars into defined benefit/defined contribution combination plans.
Case Study
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Unintended Consequences
| Traditional Defined Benefit & Cash Balance Below are several changes that has significantly impacted traditional defined benefit pensions going forward. | Fully Insured Defined Benefit Pensions Below are several changes that has impacted fully-insured defined benefit pensions going forward |
| Overfunded In the example above the porfolio grew at a constant 10%, which means it exceeded the theoretical rate of 5.5%. Eligible pre-tax contributions will decrease in the year following the year that your plan is overfunded (5.5% ). Subject to an actuarial review. All overfunded pensions that exceed the set theoretical rate of return of 5.5% will be subjected to a 50% excise tax. | Overfunded-Underfunded There are no overfunding-underfunding issues involved with a fully-insured defined benefit plan. This plan is exempt from minimum funding requirements of Code Section 412(e)(3). In addition the plan is exempt from the general non-discrimination rules set forth in Code Section 401(a)(4) because the plan complies with the requirements of Treasury Regulation Section 401(a)(4)-3(b)(5). |
| Underfunded All portfolio values less than 5.5% annual return is considered underfunded and out of compliance. The short fall must be met with cash by the plan owner, in order to satisfy minimum funding requirement [401(a)(1)(A)]. | Owner vs. Employee Contributions Owners are now allowed to sponsor a defined contribution/defined benefit combination plan. Only 40% of eligible participants are required to be placed in the pension. The remainder can be placed in the defined contribution portion without violating ERISA. |
| Owner vs. Employee Contributions Eligible employees over the age of 40 will have their required contributions by the owner increased 3% to 6% annually depending on age. | |
| Costs Any plan that is deemed to fall out of compliance (i.e.overfunding/underfunding) will incur additional costs. | Costs Annual administration fee's remain consistant. |
Pension Plan Basics
A cash balance plan is a defined benefit plan that has the characteristics of a defined contribution plan. Each year a participant's account is credited with a pay credit and an interest credit. The pay credit is dependent upon the participant's compensation. The growth of the account depends on pay credits that the employer contributes, not on profit sharing. A cash balance plan offers more portability than traditional pension plans since you can take your vested account as a lump sum whenever you terminate employment and it will not be reduced because of your age.
A fully-insured plan is simply a defined benefit pension plan where all forms of benefits are guaranteed by a single insurance company whose annuity and life insurance contracts are exclusively used to fund the plan. Loans are not permitted. Some advantages include:
- No market risk
- No full-funding limitations under ERISA 404(a)(1)(A)
- Plan may provide a maximum current tax-deductible contribution for a business
- There can be no over-funding. Therefore no 50% excise tax can be incurred
- There can be no under-funding, as the contributions are based solely on the guaranteed provisions of the level premium contracts.
A traditional defined benefit plan provides a pre-determined, level amount of benefit payments for the life of the participant or the life of the participant and spouse. The retirement benefit is calculated using a formula specified in the plan. The benefit formula may take into account service or salaries or both. Benefit formulas can also take into account Social Security benefits. The funding of a traditional defined benefit plan may include stocks, bonds, CD's & money market funds. An annual actuarial review is required to address any potential overfunding/ underfunding issues that may arise as a result of not meeting or exceeding its set hypothetical rate of return. Loans are permitted.
Your Source for a Comprehensive Retirement Plan
In addition to working with leading carriers to fund the plans, we are positioned to handle all plan administration. Our turn-key program simplifies administration by offering the following services to clients:
- Actuarial plan design
- IRS approved plan documents
- Simplified installation
- Compliance testing
- Annual government filing assistance
- Non compliant pension rescue
Our staff has an exceptional level of experience, with enrolled actuaries averaging 35 years or more of tenure in the retirement industry. These individuals have extensive knowledge of the pension and retirement markets along with a keen understanding of the issues small businesses face. This combination of skills gives us the ability to help you create a plan that truly meets your needs and maximizes the value of your plan.
To plan your retirement strategy, call Griffin & Associates, Inc. at (310) 356-7309 or visit us on the web at www.griffinpensions.com