Dual Plan: Cash Balance and New Comparability
Plans. Perfect Together.
By: George M. Morrison Esquire
New comparability profit sharing plans are a tremendous tool for companies seeking to maximize deductible contributions to owners and key employees. However, regardless of how successful the design, a new comparability profit sharing plan limits the owners and key employees to a contribution of no more than $40,000.
For many, $40,000 is a significant contribution. However, for more and more of our clients, it is not enough. For those clients, we are turning to other options. We have developed a plan design which will allocate contributions and benefits in a manner similar to the new comparability plan without the $40,000 limit. The limit depends on the circumstances.
Assume a company with the following employee census:
Employee / DOB Compensation
Owner (4/2/1955)
$200,000
Employee 1 (4/18/1956) $76,158
Employee 2 (2/11/1957) $36,000
Employee 3 (1/1/1970) $36,000
Employee 4 (8/29/1970) $30,000
This company is a good candidate for a new comparability design. A new comparability design results in 77.1% ($29,000.00 of a total contribution of $37,611) being allocated to the owners account. In addition, the proposed new comparability plan maximizes the owner at the $40,000 maximum (combined $11,000 to 401(k) and $29,000 profit sharing). While this is an effective plan design from the company and owners position, if the owner wants contributions in excess of $40,000, the new comparability design will come up short.
Proposed New Comparability Plan Design would result in allocations as follows:
Employee (Class) 401(k) Profit Sharing (% of Comp)
Owner (A)
$11,000 $29,000 (14.5%)
Employee 1(B) $3,808
$3,681 (4.8%)
Employee 2(B) $1,800
$1,740 (4.8%)
Employee 3(B) $1,800
$1,740 (4.8%)
Employee 4(B) $1,500
$1,450 (4.8%)
Total $24,909 $37,611
If the owner wants contributions to his or her account in excess of the $40,000 limit, the company should consider a cash balance pension plan design as an alternative. A cash balance plan is a defined benefit plan. Thus, the plan will have a required contribution (probably on a quarterly basis) and an actuary will calculate such required contributions. This is very different from the new comparability plan where employer contributions are made on a discretionary basis. Thus, while the plan could be amended or terminated, cash balance plans are better for companies with predictable profits and cash flow.
A cash balance plan generally allocates hypothetical contributions to a participant’s account. Such hypothetical contributions accrue annual earnings based on a specified rate of return set forth in the plan. It is the actuarial equivalent of such hypothetical account balance that determines a participant’s benefits from the plan.
A cash balance plan can allocate contribution credits in a manner similar to a new comparability plan. However, as a defined benefit plan, the $40,000 limit does not apply. Rather, a separate limit applies which varies depending on each participant’s age. On our facts, a cash balance plan design results in an allocation of 77.1% ($48,000 out of $62,253) of the "hypothetical" allocations to the owner’s account.
Proposed Cash Balance Pension Plan Design:
Hypothetical % of
Employee (Class) Credits
Comp.
Owner (A)
$48,000
24%
Employee 1(B)
$6,093
8%
Employee 2(B)
$2,880
8%
Employee 3(B)
$2,880
8%
Employee 4(B)
$2,400
8%
Total $62,253
In this cash balance plan design, the owner’s benefit is limited to $48,000. This limit depends on the participant’s age. This participant is 48 years old. An older participant could accrue benefits of over $150,000 per year. In addition to an increased limit, an older owner would have resulted in a larger disparity between the owners allocation percentage and that of other employees. In an effort to keep this material as realistic as possible, we provided a 48 year-old owner.
Joint or Offset Arrangements. On the facts discussed above, the company must choose between the new comparability plan (which provides lesser contributions but more company discretion) and the cash balance plan (which provides more contributions and less discretion). Another alternative would be a combination of both. This would provide significant advantages. First, total contributions may increase. Second, such a joint plan would provide the company with some discretion over contributions, at least with respect to the contributions to the new comparability plan. Third, the combination of plans can sometimes improve the plans’ performance in the discrimination testing (resulting in less total contributions to employees). An important limit applies in the event the company sponsors both a defined contribution and defined benefit plan. Specifically, contributions are only deductible, in that case, to the extent they do not exceed 25% of the total participant compensation.
Joint New Comparability, Cash Balance Plans could be designed to provide the following allocations and credits:
Profit Sharing Cash Balance Total
Employee
401(k) Allocation
Credits Contrib. (% of
Comp)
Owner
$11,000 $29,000
48,000
$77,000 (38.5%)
Employee1 $3,808
$3,681
4,874
$8,555 (11.2%)
Employee2 $1,800
$1,740
2,304
$4,044 (11.2%)
Employee3 $1,800
$1,740
2,304
$4,044 (11.2%)
Employee4
$1,500 $1,450
1,920
$3,370 (11.2%)
Total $24,908 $37,611 59,402 $97,013
On our facts, the joint new comparability and cash balance plans provides a tremendous plan design for the owner. The owner’s allocation is $77,000 of the total $97,013 of contributions, or 79.4%. In addition, the owner’s allocations, including 401(k) contributions, total $88,000.
All figures in the examples given are estimates and should not be relied on. A specific analysis of each client’s situation is required. In addition, the cash balance plan examples illustrate ‘hypothetical’ credits. For illustration purposes, these are assumed to be the contributions that will be required to the plan. However, such contributions are in fact actuarially calculated and will differ somewhat from the hypothetical credits.
Nothing in this material is meant to create an attorney-client relationship or constitute legal advise. Specific legal advise should be sought before any action is taken.