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PRESENTED BY: GEORGE TAYLOR MSPA; MAAA; FCA; EA georget@uplink

A Primer on Cash Balance Plans. PRESENTED BY: GEORGE TAYLOR MSPA; MAAA; FCA; EA georget@uplink.net. TOPICS TO BE COVERED. CASH BALANCE THE BASICS MAKING IT WORK; DISCRIMINATION TESTING PROPOSAL DESIGNS FROM PROPOSAL TO ANNUAL ADMIN.

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PRESENTED BY: GEORGE TAYLOR MSPA; MAAA; FCA; EA georget@uplink

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  1. A Primer on Cash Balance Plans PRESENTED BY: GEORGE TAYLOR MSPA; MAAA; FCA; EA georget@uplink.net

  2. TOPICS TO BE COVERED • CASH BALANCE THE BASICS • MAKING IT WORK; DISCRIMINATION TESTING • PROPOSAL DESIGNS • FROM PROPOSAL TO ANNUAL ADMIN. • ACTUARIAL CONSIDERATIONS (HOW ARE THE CALCULATIONS DONE) • LET’S DO A PROPOSAL TOGETHER • QUESTIONS ???

  3. CASH BALANCE THE BASICS • It is a DB plan • Accrued Benefits expressed as an account which grows at a stated rate of interest and a stated contribution. Therefore, benefits are definitely determinable. • Have become quite popular with small employers, as the courts and PPA have eliminated several of the problem areas.

  4. CASH BALANCE THE BASICS • Hybrid plan: Cash Balance; Pension Equity ; Variable benefit/annuity plan and others. • “Applicable defined benefit plan” rules under PPA. IRS in proposed regulations (REG 154-BG36; issued 12/28/07) refer to them as “statutory hybrid plans” • Plans that are statutory hybrid plans are lump sum based.

  5. CASH BALANCE THE BASICS • Statutory hybrid plans • Not subject to the special minimum lump sum distribution rules under 417(e). • Must provide for an interest rate credit of not more than a market rate of return. • At least 3 year cliff vesting • Preservation of capital • Special rule regarding future rate of return at plan termination. • Age discrimination: similarly situated employees, disregarding age, must be treated the same

  6. STATUTORY CB REQUIREMENTSPROPOSED REGS. • Safe Harbor for Age discrimination: as of any date the benefit of any participant would not be less than the benefit of a similarly situated younger participant. Otherwise must test under 411(b)(1)(H)(1). • Would appear that: Job title; ownership %; compensation; location; employer; service could all be used. • Not sure status unrelated to the workplace would work. Has caused little problems when designing a plan.

  7. STATUTORY CB REQUIREMENTSPROPOSED REGS. • Market Rate of Return: • Third segment rate • Discount rate on 3 month Treas. Bills +175 bp • Discount rate on 12 month Treas. Bills +150 • Yield on 1 yr. Treas. Constant Maturities+100 • Yield on 3 yr. or shorter Treas. Bonds+50 • Yield on 7 yr. or shorter Treas. Bonds+25 • Yield on 30 yr. or shorter Treas. Bonds+0 bp

  8. STATUTORY CB REQUIREMENTSPROPOSED REGS. • Market Rate of Return • Cost-of-Living index as described in 1.401(a)(9)-6, A-14(b) +300 bp. • May be credited more than once a year. What about distributions made doing the year? • Minimum guaranteed rate of return: Reserved • A fixed rate of return: Reserved • Equity-based rate of return: Reserved • ASPPA providing comments or all of the above. • I like a fixed rate, and have used 5.5%

  9. STATUTORY CB REQUIREMENTSPROPOSED REGS. • Lots of guidance on conversions, which will not be covered beyond this slide. • The basic principal is that each employee starts with an account balance/accrued benefit equal to the Actuarial Equivalent (including 417(e) minimum lump sum) of their Accrued benefit. • Will there be 411(d)(6) relief or will the value have to be recalculated each year?

  10. STATUTORY CB REQUIREMENTSPROPOSED REGS. • Regs. will not be effective until PY beginning on or after 1/1/09. However can be relied on. • Any good faith effort to comply is OK but must follow the law.

  11. CASH BALANCE THE BASICS • ADVANTAGES OVER A STD. DB OR DC * Higher Contribution addition than a DC plan (amount necessary to fund for 415 DB limit) * Easy for the employees to understand * A stated rate of return (must be a “market rate of return”).

  12. ADVANTAGES OVER A STD. DB OR DC *Can convert a current DB plan * Can provide past service benefits * More meaningful to younger employees and a mobile workforce *Answers the question: What is in my account? (which will be more difficult to answer for DB plans under PPA). Therefore ideal for the partner plan or the petty owners (who count how many pencils each use).

  13. ADVANTAGES OVER A STD. DB OR DC * Can have traditional DB benefit for some of the employees * Excess earnings reduce future contributions * May use prior salaries to establish 415 average salary

  14. CASH BALANCE THE BASICS • DISADVANTAGES OF CB/DB PLANS * CB: An Individual Designed Plan; increased document fees, user fees, delays in getting approval. *DB/CB: Subject to benefit restriction rules and top 25 HCE LS restriction rules * CB: Required contribution will not be the same as the sum of the amount going into the accounts (funding whip-saw). *CB: Must (almost always) be general tested *CB/DB: May be subject to PBGC (could be a good)

  15. DISADVANTAGES OF CB/DB PLANS *CB/DB: Subject to 401(a)(26) * CB/DB: Must design plan to not violate 415. *CB/DB: May limit the deductible contribution to the DC plan to 6% of Compensation * CB/DB: Must comply with the top heavy DB requirements (usualy provided in DC plan) *DB/CB: Requires the services of a Actuary

  16. DISADVANTAGES OF CB/DB *CB: Can not use wear away for conversions * CB: Three year cliff vesting required *CB: Choosing a “market rate of return” may be difficult. * CB/DB: Poor earnings may increase cost * CB/DB: Must design conversions to avoid potential back loading issues (hopefully the IRS, with the recent communications from Congress will change their position). Some relief provided in Rev. Rul. 2008-7

  17. MAKING IT WORK; DISCRIMINATION TESTING LIKE CROSS TESTING A DC

  18. MAKING IT WORK; DISCRIMINATION TESTING • DB/DC: Coverage requirements under 410 (b) • DB: Benefiting rules under 401(a)(26) • DB/DC: Average benefits testing under 410 (b) • DB/DC: Minimum top heavy benefits under 416 • DB/DC: Maximum benefit limitations under 415 • DB/DC: Gateway considerations under 401(a)4 • DC/DC: Deduction limits under 404 • DB/DC: Discrimination testing under 401(a)4 • DB: Funding rules under PPA

  19. Benefiting Rules Under 401(a)(26) • 401(a)(26): • 40% or at least 50 employees must benefit. • The Paul Schulz Benefiting Rule: • ½% per year of service minimum • No one-day wonders • Facts and Circumstances

  20. Maximum Allowable Benefits Under 415 • Note the advantage of the defined benefit maximum is the use of the highest 3 consecutive years compensation • Do not need current years earned income to be as great as prior years • Will affect DC annual additions and discrimination testing

  21. Deduction Limits Combined Plans • Can always deduct 6% of Compensation as a DC contribution • Can always deduct 25% of Compensation to DB plan (therefore total of 31% if all are in both plans) • Under recent statement from IRS can always deduct 150% of unfunded Target Liability. • Starting 2008 no 404 limits at all for any DB plan subject to PBGC

  22. DESIGNING PROPOSALS

  23. ALL PROPOSALS-ASSUMPTIONS

  24. Proposal #1 Data

  25. Proposal #1 current New Comp planMax HCE (30,500) and 3.3% for NHCE

  26. Proposal #1 current New Comp planMax HCE (30,500) and 4.42% for NHCE

  27. Proposal #1 Assume it is a CB planHCE=30,500 NHCE=5%

  28. Proposal #1 Assume it is a CB planHCE=30,500 NHCE=6.8%

  29. Proposal #1 Assume Combo: HCE 30500NHCE%: CB=1.05, PS=2.75%

  30. Proposal #1 Assume Combo:HCE= 173,000NHCE%: CB=1.05, PS=10%

  31. Proposal #1 Assume Combo:HCE= 173,000NHCE%: CB=1.05, PS=10%

  32. Proposal #1 Assume Combo:HCE= 173,000NHCE%: CB=1.05, PS=10%

  33. Proposal #1- IF NRA 62

  34. Proposal #1- IF NRA 62

  35. Proposal #1 Assume Combo: • Do not overlook the fact that almost the same plan design can be accomplished by a Combo Traditional DB plan and a PS plan. • DB plan to provide ½% of pay per year of service to all HCE and the Max. 415 benefit to the HCE. • PS plan has each employee in a rate group. • Often due to the additional expense associated with CB plan the client makes this decision.

  36. PROPOSAL#2-CASE STUDY

  37. PROPOSAL#2-SUB GROUP CONT

  38. PROPOSAL#2- TEST THE PLAN

  39. PROPOSAL#2 CONT. AMOUNT

  40. ACTUARIAL CONSIDERATIONS

  41. ACTUARIAL CONSIDERATIONS • Need to have a Funded Target Liability of at least 110% in order to pay lump sums to HCE. • What contribution do you recommend or do you simply communicate the Min & Max? • Dealing with the effect of Funding whip-saw

  42. ACTUARIAL CONSIDERATIONS • Getting valuation done in time to avoid benefit restrictions • EOY or BOY valuation date? • EOY makes the most sense. • PPA current benefit restriction rules after 2008 is a problem. Without a fix each year benefit will be frozen (after the plan is five years old). • Thec. Corrections will fix this, and IRS has stated their guidance will look like Notice 2008-21. • Potential change in funding method problem post 2008 PY.

  43. ACTUARIAL CONSIDERATIONSHOW THE CALCS ARE DONE • Let’s look at Proposal #1 • PPA segment rates:5.72%, 5.92% & 6.09% • Years to Retirement: • EE#1: 9 years; second rate of 5.92% • EE#2: 21 years third rate of 6.09% • EE#3: 32 years third rate of 6.09% • Assume lump sum payment at retirement • Funding Target Liability at ED=$0 • Contribution= $156,947 • Amount Allocated= $162,735

  44. ACTUARIAL CONSIDERATIONSHOW THE CALCS ARE DONE YR#1

  45. ACTUARIAL CONSIDERATIONSHOW THE CALCS ARE DONE YR#2 • Assets= $156,947 • Target Liability = $166,235 • Target Liability*1.5-Assets=$92,406 • Target Normal Cost=$157,572 • Max. Cont.=($92,406+$157,572) or $249,977 • Sum of Account balances=($162,735*1.055 + $162,735) or $334,420. • Recommend Cont= ($334,420*110%-$156,947) or $210,915 • .

  46. GOING FROM PROPOSAL TO ANNUAL AD. Or who designed this mess?

  47. RULES FOR PROPOSALS • Advise the client, often, in writing of the need for accurate data, and the need to advise you of any substantial changes or anticipated changes in data. • Never use permitted disparity • Don’t get “cute” • Don't use “napkin data” • Don’t cut it too close just to prove you are smarter than the other firm that did a proposal • Leave some room • Consider PT and short service employees (they are usually younger and will help the test).

  48. DOCUMENT DESIGN • Remember it is a DB plan, there is no dealing with it at the end of the year like a New Comp. Plan • Consider not having a 1,000 hour requirement or an EOY requirement to get a Contribution. • May want to state the benefit for the HCE in terms of the 415 limit. • Have the same Elig. Provisions as those who share in the PS plan • In some cases it may be wise to separate the 401(k) plan from the PS plan.

  49. ANNUAL ADMINISTRATION • It is all about passing discrimination testing • Remember the testing is done at the end of the year so expect surprises • Try to work a year in advance. • Get the data of all the employees. • Look at who will be Elig. next year and who shared this year and will not share next year. • Advise the client, often, in writing of the need for accurate data, and the need to advise you of any substantial changes or anticipated changes in data

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