It starts with questions
dlan Design requires the complex understanding of many coexisting variables. It starts with questions: How many employees work full time? How much is the business looking to contribute to the plan annually? Are annual earnings steady or do they fluctuate? How much do officers earn? How much do rank and file employees earn? Is there high turnover or do employees work long term? Would a defined benefit plan in combination with a defined contribution plan achieve the client's stated goals?
There are many plan options and designs possible under ERISA. Which one fits your company best? Let's work together and start asking the right questions.
When Having Two Plans Makes Sense
An opportunity came to us where a doctor needed a new plan. He was in his late 40s, his only other employees were his wife as the office manager and an entry level part time medical assistant. His annual revenues could justify an annual contribution of up to $250,000.
We input the company's census data (including all three employee salaries and hours worked) into our software and determined the he could make an annual company contribution to a maximum of $200,000 under a standard Defined Benefit Pension Plan. This was great, but he was curious on how he could get closer to $250,000.
We presented a second proposal which was a Cash Balance plan, and his target of $250,000 was reached. However, the cost of operating a Cash Balance plan was higher than he was fully comfortable with, so we simply proposed he have a Defined Contribution Plan in conjunction with a Defined Benefit Plan.
This was perfect for his needs. We installed a new Defined Benefit Pension Plan and a new Defined Contribution Plan (401(k), Safe Harbor, and Profit Sharing). We were able to reach a total contribution maximum through both plans of $241,000 and kept his annual administration costs low.
How Age Affects Contribution Limits
Defined benefit pension plans are helpful in planning for retirement security. They were originally intended to act much like Social Security benefits, where the plan provides a fixed amount of benefit each month after meeting certain and service conditions.
Employers setting up DB plans look to the plan for a reliable income at retirement, based on the income level and length of service of their participating employees.
In the process of planning for payments from a defined benefit plan, the plan sponsor is required to provide a reserve of funds in a trust to pay for those expected benefits. The rules for setting that reserve are determined by actuarial mathematics in two basic steps, where:
1) Expected values are used to project the timing and amount of future payments, based on mortality tables, expected future pay, and the expected starting date of the benefits.
2) Future payments are priced, based on expectation that the reserves will be invested at some reasonable yield or interest rate, so that they grow into the amount needed when the payment is due.
Assume you are targeted to receive a benefit at retirement in 20 years of $156,000. If you could earn 3%, a reserve of $86,373 would be needed. If you could earn 7%, a reserve of $40,313 would be enough.
If you only have 10 years to target $156,000, the reserves would be $116,080 at 3%, and $79,300 at 7%. 10 years less time requires more money up front.
Since the limits on defined benefit plans are capped at 100% of pay, or a dollar amount of $17,500 monthly for 2015, the maximum fund needed at age 62 would be about$2.7 million. Using a 5% assumption rate, you would have an allowable reserve at different ages that looks like this:
Age (future years) Reserve
57 (5 years) $2.1M
52 (10 years) $1.7M
42 (20 years) $1.0M
22 (40 years) $0.4M
The difference in reserves also explains why pension benefits (and maximum limits) depend on the age and benefit level of each participant. Thus, younger employees have lower deduction limits than older employees. It is the direct effect of compounded interest.