Menu

Does a defined benefit plan make sense for me? Any experience with this?

Home Retirement Accounts Does a defined benefit plan make sense for me? Any experience with this?

  • White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 937
    Joined: 02/06/2016

    Does anyone know of any reliable resource to learn a bit more about defined benefit plans?

    #241065 Reply
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 3079
    Joined: 09/18/2018

    Pardon the interruption, the IRS has some pretty good information besides forms, instructions and regulations.

    https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-defined-benefit-plan

    Not being sarcastic, you may have already looked.

    #241078 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 937
    Joined: 02/06/2016

    Thanks Tim, the basic resources regarding defined benefit plans on this forum and on the bogleheads forum are fairly basic.  The rules for these plans get complex with funding requirements and non-discrimination rules.  So clearly we would need sophisticated advice.  At the same time, I like to learn as much as possible, to be an educated layperson to make reasonable decisions.

    For example, the pension consultant that spoke to us this week is AUM compensation for the defined benefit portion of the plan, and he mentioned putting life insurance inside the plan.  From this thread I learned that all types of compensation models and asset allocations including self directed are allowed.  I also learned that life insurance inside the plan is fully optional.  Finally from some of the other threads on the various forums I learned that a conservative asset allocation with lower risk during the funding phase is recommended by many experts.

    Any other thoughts or advice are appreciated.  I am generating a list of questions for next week’s meeting.  We are also going to talk with our CPA, our TPA and other pension consultants to get a variety of opinions.

    #241084 Reply
    Avatar jacoavlu 
    Moderator
    Status: Physician, Small Business Owner
    Posts: 2381
    Joined: 03/01/2018
    the pension consultant that spoke to us this week is AUM compensation for the defined benefit portion of the plan, and he mentioned putting life insurance inside the plan

    Click to expand…

    super skeptical hippo eyes toward this guy

    I’m assuming there are going to be funds of yours and additional employees in the pool. Given this I’m not sure I would direct the investments myself. You want a good flat fee fiduciary advisor. Kon Litovsky would be one person to talk to.

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #241091 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 937
    Joined: 02/06/2016

    the pension consultant that spoke to us this week is AUM compensation for the defined benefit portion of the plan, and he mentioned putting life insurance inside the plan

    Click to expand…

    super skeptical hippo eyes toward this guy

    I’m assuming there are going to be funds of yours and additional employees in the pool. Given this I’m not sure I would direct the investments myself. You want a good flat fee fiduciary advisor. Kon Litovsky would be one person to talk to.

    Click to expand…

    Yes, I asked directly, “How are you compensated for your services?”  When I heard AUM and when he recommended considering some life insurance inside the defined benefit plan, my spidey sense of caution!!! went way up.

    We have a very good TPA, and they have always directed us well.  We also have a good CPA to ask for advice and direction.  Basically, what I got out of the meeting is that the opportunity to save with significant income tax deferral got my attention.  At the same time, the distributions will eventually be taxed (although they can potentially be stretched out for a long time by heirs), and depending on the state of our union and the estate taxes, the savings on front end income taxes could also be eaten up by estate taxes on the back end.

    #241092 Reply
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 3079
    Joined: 09/18/2018

    “(although they can potentially be stretched out for a long time by heirs)”
    Considering the stretch being greatly trimmed down on bills passed by the bipartisan house and senate (5 yrs/10 yrs) for other than spouse, I would chew on that for a long term plan with the numbers you are talking about.
    Just saying, a little smoke there to consider.
    By the way, your beneficiaries will thank you for taking care of the taxes! Funny how that works, “WBD even paid the taxes, what a great guy!”
    Sorry for the sarcasm, tax free is a great gift.

    #241111 Reply
    Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 926
    Joined: 01/09/2016

    I am the sole owner of a business.  The business is very generous with contributions to our safe harbor/401k/profit sharing plan for all employees.  The non-highly compensated employees get a 3% safe harbor contribution and a 3% employer paid contribution.  They also get a cash bonus.  The highly compensated employees get 6% employer paid contributions plus generous annual cash bonuses.

     

    A pension consultant tells me that I should add a defined benefit combination plan for myself as the owner.  They are recommending the following:

    1. Increase contributions for NHCEs to 7.5% from the current 6% (3+3) which will pass all fairness testing rules and in turn allow all kinds of flexibility for the HCEs and the business owner.  The money for this extra 1.5% could come from a small reduction in the cash bonuses or be paid as additional compensation.

    2. Reduce the employer paid contribution to the HCEs a bit, but allow the HCEs to contribute additional amounts (up to very large amounts) from their own elective salary deferrals in a very flexible and individualized manner.  The HCEs will be able to save so much tax with these more flexible and larger deferrals that they will come out way ahead at no cost to the employer because of their enhanced tax savings. (We are located in a very high tax state.) . The employer will save a bit by continuing to make generous contributions, but a bit less than before because of the other benefits to HCE employees.

    3. Add a combination defined benefit plan only for me as the sole owner, and fund it with as much as a maximum of roughly 3M in contributions over the next several years (3-10 years).  When fully funded, dissolve the plan and roll it over to my 401k.

     

    My questions:

    1. Does adding this defined benefit combination plan sound like it makes sense?  I have lots of extra income that I am currently putting into taxable accounts because I can only contribute 62k/year to tax deferred with the current plan setup.

    2. Can I end up with too much in tax deferred accounts?  Would having too much in tax deferred potentially lead to more estate taxes, when in contrast paying the tax now and having less in taxable accounts (relatively equivalent post tax value but higher current balance in a tax deferred account where the taxes would be owed upon withdrawal) potentially keep us under the estate tax limits (whatever they may be when the second one of us dies sometime off in the future)?

    3. What type of investments are appropriate for a defined benefit plan?  The pension consultant said that relatively modest yield, safe and stable investments work well during the funding phase of a defined benefit plan.  The investments can then be further diversified once the plan is dissolved and rolled over to my 401k.

    4. Should there be life insurance in the plan?  (One of the referral sources who connected us with the pension consultant for this plan works for an insurance company and recommended life insurance to cover potential estate taxes.)

    4. The asset manager of the defined benefit plan is compensated by an AUM fee.  Is this typical or are there other fee structures for defined benefit plans?

     

    This all seems somewhat complex to me with lots of moving parts.  Thanks in advance for any advice…..

    Click to expand…

    This is an article I’ve written specifically to address Cash Balance plans for medical/dental practices:

    Cash Balance Plans for Solo and Group Practices

    Please note, Cash Balance.  There is no need for DB plans anymore, and there are advantages to CB plans (which was also my experience looking at various designs provided to me by actuaries), and we now have a pre-approved plan document available which brought  the cost of these plans down.

    When you consider the cost vs. benefit for a CB plan, you have to look at the bigger picture.  Usually adding a CB plan increases % to owner, which is the primary measure for me.  However, there is also a cash flow concern and whether the timing is right for you (for example, if you have high level of high interest debt, I don’t recommend this type of plan in favor of paying your debt down, unless your income is quite high to allow for both).

    No life insurance, this one is quite easy. There is NEVER a need for insurance in a Cash Balance plan and there is plenty of articles written on this topic. It sounds like you are getting a sales job done on you, and that’s not good.  A low cost portfolio of index funds (mostly bonds) is going to be fine for a CB plan that will exist for as few as 3 years and as long as 10 (which is still not very long at all).  But if your crediting rate is rather low (say 3%, which is based on plan design specifics), then all bonds will be fine. You simply tilt your 401k plan allocation to stocks more, and this will end up just like a single portfolio with bonds in the CB plan and stocks (or mostly stocks) in the 401k plan.

    By the way, I see insurance sold specifically in DB plans, for some reason they like DB plans more for that purpose (which is yet another clue that someone is trying to sell you something).

    And of course, no AUM fees.  That’s the first thing that you should be careful about.  These fees eat into your bottom line, and should have no place in retirement plans, period:

    Evaluating AUM Fees for Small Practice Retirement Plans

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #241550 Reply
    jfoxcpacfp jfoxcpacfp 
    Moderator
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 8137
    Joined: 01/09/2016
    2. Can I end up with too much in tax deferred accounts?  Would having too much in tax deferred potentially lead to more estate taxes, when in contrast paying the tax now and having less in taxable accounts (relatively equivalent post tax value but higher current balance in a tax deferred account where the taxes would be owed upon withdrawal) potentially keep us under the estate tax limits (whatever they may be when the second one of us dies sometime off in the future)?

    Click to expand…

    This is the only question I’m going to touch. Whether the investments are in tax deferred or in taxable, the estate taxes will be the same. otoh, your heirs will owe more income taxes on tax-deferred accounts while they will get a basis step-up on taxable accounts. Roth account balances are included in the taxable estate but heirs pay no taxes on them. They are the most desirable.

    While I cannot define what is “too much”, adding a CB plan to your 401k can easily yield RMDs at age 70 that will render you permanently in the top tax bracket. If/when you retire early, Roth conversions can be very beneficial. Your CPA and financial planner can give you very valuable guidance for planning at this stage.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~
    http://www.fox-cpas.com/for-doctors-only ~ [email protected]

    #241567 Reply
    Avatar orthodds 
    Participant
    Status: Dentist
    Posts: 147
    Joined: 11/07/2017

    Anyone know anything about Kravitz?  Affiliated with Ascensus and focused on CB plans.  Just wondering if they are worth talking to.

    #241579 Reply
    mb(a)CPA mb(a)CPA 
    Participant
    Status: Accountant
    Posts: 18
    Joined: 04/01/2019

    AUM fees for a defined benefit plan?  Is anyone concerned about the incentive this creates given that it is best for defined benefit plans to be conservatively invested?

    #241589 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 937
    Joined: 02/06/2016

    Please note, Cash Balance.  There is no need for DB plans anymore, and there are advantages to CB plans (which was also my experience looking at various designs provided to me by actuaries), and we now have a pre-approved plan document available which brought  the cost of these plans down.

    When you consider the cost vs. benefit for a CB plan, you have to look at the bigger picture.  Usually adding a CB plan increases % to owner, which is the primary measure for me.  However, there is also a cash flow concern and whether the timing is right for you (for example, if you have high level of high interest debt, I don’t recommend this type of plan in favor of paying your debt down, unless your income is quite high to allow for both).

    Click to expand…

    Thank you Kon for linking your cash balance article.  Very helpful.

     

    Is it always true that a cash balance plan is better than a DB plan?  Does this depend on the circumstances, or is this always the case?

    This business is already intentionally generous to all of the NHCE and HCE employees.  The outside pension consultant who was pitching us (probably salivating at the thought of some juicy AUM fees) said that a small increase in contributions for NHCEs from 6% to 7.5% would pass all fairness testing and allow all kinds of flexibility for both HCEs and the owner.  This increase in contributions for NHCEs would only cost 0.12% of our annual revenue.

    The owner is approaching retirement age, pays large income tax bills every year, funds significant sums to taxable each year, has no outstanding debt of any kind left, and has sufficient extra income to fund a DB or Cash Balance plan.

    #241600 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 937
    Joined: 02/06/2016

    Whether the investments are in tax deferred or in taxable, the estate taxes will be the same.

    Click to expand…

    This sounds funny to me.

    Let’s say I have 1M to invest and I invest it in taxable after paying 50% tax.  I now have 500k and I die.

    Now let’s say I have 1M to invest and I invest it in my tax-deferred cash balance plan.  I now have 1M and I die.

    Are you saying the estate tax on the 500k and the 1M is the same if I am over the estate tax exemption?  Not sure I am following you there.

    #241601 Reply
    jfoxcpacfp jfoxcpacfp 
    Moderator
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 8137
    Joined: 01/09/2016
    Earnest refinancing bonus
    Let’s say I have 1M to invest and I invest it in taxable after paying 50% tax.  I now have 500k and I die.

    Click to expand…

    I’m not following paying 50% tax for investing in a taxable account.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~
    http://www.fox-cpas.com/for-doctors-only ~ [email protected]

    #241603 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 937
    Joined: 02/06/2016

    Let’s say I have 1M to invest and I invest it in taxable after paying 50% tax.  I now have 500k and I die.

    Click to expand…

    I’m not following paying 50% tax for investing in a taxable account.

    Click to expand…

    Living in a very high tax state, with high income, high marginal tax rates, I would pay 37% federal and then state income tax on top of that.  In my case I pay 45.8% total marginal income tax, so I am rounding it to 50%.

    Example: I earn 500k, pay almost half of that to income taxes, then invest what is left after paying the tax in my taxable account.  If I invest the 500k in tax deferred, the entire 500k goes into the investment, leaving a much larger balance but subject to income tax upon withdrawal, or more estate tax upon death.

    #241608 Reply
    jfoxcpacfp jfoxcpacfp 
    Moderator
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 8137
    Joined: 01/09/2016

    Well, you are still investing $1M in a taxable account. Just because you didn’t get a tax deduction for investing $1M in a taxable account is kind of like saying you bought a piece of land for $1M but the net impact on your estate is to calculate the taxes you didn’t save by not getting to deduct the purchase of the land. I don’t believe it is practical to calculate net worth by all of the taxes you didn’t save during your lifetime, but I think I understand what you are saying.

    In the final spreadsheet in the sky, $1M in investments at death is either going to be taxed twice (pre-tax retirement accounts) or taxed once (taxable accounts). btw, the executor will have the option of not choosing to elect a stepped up basis in calculating the value of the estate, but not doing so will have an income tax impact, just as electing a step-up with have an estate tax impact. And that’s a different topic.

    So maybe we’re kind of saying the same thing, but I disagree with the rationale. And it really pains me to say that to White.Beard.Doc.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~
    http://www.fox-cpas.com/for-doctors-only ~ [email protected]

    #241612 Reply

Reply To: Does a defined benefit plan make sense for me? Any experience with this?

In case of a glitch or error, please save your text elsewhere, clear browser cache, close browser, open browser and refresh the page.

Notifications Mark all as read  |  Clear