Overview of the Pension Protection Act of 2006 as it applies to DB/DC combo plans

PPA ’06 ChangesIncreases Defined Benefit (DB) plan

deduction limits and repeals combined deduction limit when adding a Defined Contribution (DC) plan

Combined plan deduction limit for 404(a)(7) does not apply if the ER Contribution to a DC Plan does not exceed 6% of compensation Could maximize the DB contribution Replaces the old 25% rule

PPA ’06 Changes to DB/DC PlansIf the Employer contributions to the DC plan do

exceed 6% of compensation, the new combined limit of 31% of compensation applies

Starting in 2008, combined deduction limit does not apply to PBGC-covered plans regardless of level of contributions

Non-PBGC plans still subject to the above rules Plans can not elect to be covered by PBGC!Though hiring children over 25 years might help!

Strategy One: Emphasize the DBER contributions to a DC plan, especially 401(k), are

limited to 6% of total compensation (higher if PBGC)The 6% to a 401(k) plan can be used to satisfy top

heavy, safe harbor requirements AND gateway, MAX DB

Strategy Two: Emphasize the DCMaximize the contribution to the owners under a PS or

401(k) plan, compute the percentage of ER contribution as a % of compensation, subtract this amount from 31%.

The difference is the contribution to the DB plan

Two Major Strategies

Aggregation of Plans

THIS IS WHAT MAKES THE COMBO WORK!!!

In addition to designing plans individually to use the new limits, we can combine the plans using “permissive aggregation” thus testing both plans together: This helps pass coverage and discrimination

tests while often reducing the amount given to rank and file

Points to ConsiderThe defined benefit plan can be traditional,

tiered and/or cash balance Traditional/Tiered are based upon historical salary

averages This creates a required annual contribution even if

the compensation drops, while Cash balance plans normally written as a percent of

current compensation, so if comp drops, so does the contribution Easy to communicate to employees in terms of

deposits and what is owed upon retirement or termination

Plan Designs in Action

SEPS are not always a GOOD idea!It takes $196,000 of W-2 compensation to get

to $49,000 in a SEP (25% of compensation)It takes $130,000 of W-2 compensation to get

to $49,000 in a 401(k) ($16,500 plus 25% of comp)

But MUCH lower W-2 compensations to get to $49,000 in a CB/DC Combo arrangementAge 50, $35,000 - Age 55, $33,000$16,500 plus 6% of compensation plus CB costs!!!(No compensation = No required contribution!)Need to be careful when a ER is a sole proprietor

One Person DesignsCombination of Defined Benefit Plan:

Traditional or Cash Balance with a Defined Contribution Plan designed to maximize contributions, the greater of:31% of compensation ($75,950 for 2009) plus

401(k) salary deferrals ($16,500), or 6% of compensation plus salary deferrals in a

401k Plan plus 100% of compensation in the cash balance or DB plan limited by 415 (can be greater than 31%)

Catchup deferrals of $5,500 can be added to both

One Person Designs Cash Profit Balance Sharing 401(k) NAME Contribution Contribution Contribution

Totals -------------- --------------- --------------- --------------- -------------

Up to 31% of Compensation - $245,000 Owner 30.. 43,450 32,500 16,500 92,450 Owner 35.. 43,450 32,500 16,500 92,450 6% plus cost of DB – Comp at $245,000 Owner 40.. 77,979 14,700 16,500 109,179 Owner 45.. 101,912 14,700 16,500 133,112 Owner 50.. 133,195 14,700 22,000 169,895 Owner 55.. 174,077 14,700 22,000 210,777

One HCE Design If the employer is a professional service

corporation with less than 25 employees, then the limits are 6% of comp plus salary deferrals for the 401(k) Plan and Maximum for the Cash Balance/Defined Benefit Plan (or 31% if 401(k) goes over 6%)

If the employer is NOT a professional service corporation with less than 25 employees and covered by PBGC, then the limits are 25% of comp plus salary deferrals for the 401(k) Plan and maximum for the Cash Balance/Defined Benefit Plan

Age Comp PS ContributionSafe

Harbor Deferrals Totals

Dr. S A 68 245,000 25,150 7,350 22,000 54,500Subtotal 245,000 25,150 7,350 22,000 54,500

PA1 B 58 70,000 8,400 2,100 0 10,500PA2 B 48 70,000 8,400 2,100 0 10,500

Subtotal 140,000 16,800 4,200 0 21,000

Er Totals $385,000 $41,950 $11,550 $22,000 $75,500Total ER

% of Comp 10.90% 3.00% Owners % 72.19%

3% Safe Harbor plus 12% profit sharing contribution to everyone Dr. S's PS Contribution limited by 415

One HCE Design-Comp/Comp

Age Comp PS Contribution Safe Harbor Deferrals Totals

Dr. S A 68 245,000 25,150 7,350 22,000 54,500Subtotal 245,000 25,150 7,350 22,000 54,500

PA1 B 58 70,000 4,665 2,100 0 6,765

PA2 B 48 70,000 4,665 2,100 0 6,765

Subtotal 140,000 9,330 4,200 0 13,530

Er Totals $385,000 $34,480 $11,550 $22,000 $68,030Total ER

% of Comp 8.96% 3.00% Owners % 80.11%

3% Safe Harbor plus 6.67% to Rank and File (integrated basis) Dr. S's PS Contribution limited by 415

One HCE Design-Integrated

Age Comp CB Contribution401(k) ER

Contribution Deferrals Totals

Dr. S A 68 245,000 120,000 0 5,500 125,500Subtotal 245,000 120,000 0 5,500 125,500

PA1 B 58 70,000 2,100 8,400 0 10,500PA2 B 48 70,000 2,100 8,400 0 10,500

Subtotal 140,000 4,200 16,800 0 21,000

Er Totals $385,000 $124,200 $16,800 $5,500 $146,500Total ER

% of Comp 32.26% 4.36%Owners %

85.67%

•The Cash Balance Plan •The 401(k) Plan `100% to Class A limited to 415/or passing test `0% to Class A`3% to Class B `catch up salary deferrals `12% to Class B

One HCE Design- Combo Design

Multiple HCEs and EmployeesThe following designs are for a client with one

major owner (54%), two minor shareholders (23% each) plus six rank and file employees

Combination of a Cash Balance Plan, 3% NHCEs, set $ for MSH and Safe Harbor 401(k) Plan , 3% SH plus 3.7% PS to NHCEs

Objective – Exit Strategy for Majority OwnerMaximize the Majority OwnerStructure transfer of Ownership to Minority

Owners

Age Comp CB PLAN ER DEPOSIT DEFERRALS TOTALS

HCE1 55 245,000 230,671 7,350 22,000 260,021

HCE2 42 110,000 11,000 3,300 16,500 30,800

HCE3 41 100,000 11,000 3,000 16,500 30,500

Subtotal 455,000 252,671 13,650 55,000 321,321

NHCE1 35 80,000 2,400 5,360 0 7,760

NHCE2 32 65,000 1,950 4,355 0 6,305

NHCE3 29 50,000 1,500 3,350 0 4,850

NHCE4 39 45,000 1,350 3,015 0 4,365

NHCE5 27 45,000 1,350 3,015 0 4,365

NCHE6 24 30,000 900 2,010 0 2,910

Subtotal 315,000 9,450 21,105 0 30,555

Plan Totals 770,000 262,121 34,755 55,000 351,876

Percent to HCEs 91.32%

Percent of Compensation 38.55%

Clearly identify the client’s objectives

Revisit those objectives frequently (annually?)

Design the simplest plan or combination of plans to meet those objectives

General test designs usually provide better results than safe-harbor design

However, with very small groups these designs require constant tweaking as employees come and go

Exception: Young HCEs will always wreak havoc with a general-tested plan design unless they are specifically excluded from participation. If they are to be included, a safe harbor design may be the best

Owners and partners of different ages may require DB/DC combination designs to meet different objectives

When using a general test design, rarely hurts to cover all employees in the arrangement. Helps with nondiscrimination testing, improves the deductible limit, and helps reduce the variability of year-to-year results.

Caution: May be difficult to amend plan under 1.401(a)(4)-11(g) – AFTAP less than 60% may be a problem

For younger HCEs, it generally makes sense to maximize the defined contribution arrangement, as it is impossible to make up for lost DC contributions. In a defined benefit plan (assuming at least 10 years of participation), a participant can make up for years where the DB was not maximized

Question: Do you “burn” your DB 415 limits for a younger HCE? (Need guidance on MASD (multiple annuity starting date) rule for 415)

Any prior DB plan accruals?Have any members of the controlled or affiliated service group maintained a defined benefit plan in the past?

Continue to maintain existing profit sharing or 401(k) plan?

DB Plan to be covered by PBGC?

Goal in establishing a defined benefit plan?Principals who are 10-15 years from

retirement Younger principals’ goals?Maximizing current take-home pay or savings?Attract or retain key personnel?Any industry-standard plan types or

provisions?Can the business maintain the plan(s) for the

long haul?What about the impact of changes in the

market?

New Limits for 2009Salary Deferral - $16,500Catch-up - $5,500 for those over 50 years

of ageDC Limit - $49,000 annual additions DB Limit - $16,250 per monthCompensation Limit - $245,000Highly Compensated - $110,000Taxable Wage Base - $106,800

Next StepComplete the Request for Information on

our website. We will provide you a side by side comparison of how a combo design can work for your client!

Contact RPS, Inc. at 407-365-3490 or 888-376-7222, or visit us at www.webpensionplans.com

Technical questions can be directed to Jeffrey T. Sparks, QPA, CLU, ChFC, FLMI