Partnership DB Plan

[Blinky the 3-eyed Fish]

Partners have different ages and thus have different levels of benefit value in a traditional DB plan. I wonder what philosophies you folks are using to "assign" costs to each partner in these DB plans of partnerships in year 2, 3, ...... Of course each partner wants to make sure they aren't getting the shaft by having a greater percentage of costs versus benefits assigned to them than other partners.

[FAPInJax]

No easy answer with a traditional plan. Generally each partner has a designated amount that is split between their compensation and contribution (after generating costs for the employees that are fixed. This amount is split by the actuarial method and controlled by the formula. Once the formula is set - the contribution follows. There is no further choice at that point.

This is why, in my opinion, cash balance plans have become so popular for maintaining level contributions regardless of the age of the partner (almost).

[tymesup]

We've been using individual aggregate funding and assigning the normal cost to each partner. Holding my nose helps a little.

We're converting some of them to cash balance, so we at least have a stationary target to hit.

[Blinky the 3-eyed Fish]

And that last post is an example of where a large disconnect begins in assigning cost under the funding method versus assigning truer costs. For example, under IA a benefit formula funding 10% of Hi-3 per year of participation will cause a relatively low normal cost for someone 20+ years to retirement versus someone within 10 years.

I know of nothing that requires costs to be allocated in anything but a reasonable manner. Of course I believe it to be much more reasonable to allocate the cost much differently than what the funding method produces. Any different approaches?

[Andy the Actuary]

Assuming all of the partners are HCEs, there should be no problems having different benefit formulae so long as there is no discrimination against NHCEs. This suggestion may work if we're talking about a small group.

[Dougsbpc]

How about allocating the costs on PVAB's? If it is a small plan this would be the fairest way would'nt it?

[JAY21]

I tend to use Doug's recommended approach (based on ratio of PVAbs) for when the partners eventually get their PVABs upon plan term in the future, and quickly look back at what they each "contributed" for each year plus some interest credit, it bears a better relationship to what they think they should be getting.

[Blinky the 3-eyed Fish]

Let me throw a wrinkle into simply basing it on PVAB's with a more complex plan design. A good example of how PVAB's can get screwy is with an offset plan.

Say there are two partners of the same age, compensation and benefit formula, thus equal PVAB's without considering the offset.

Year 1: costs are allocated on PVAB's - no issue

Year 2: partner A has tremendous DC returns and thus has a reduced DB. Partner B is the opposite with very poor DC returns and an increased DB. Partner B is allocated a higher amount than A.

Year 3: this time partner A has poor returns and an increased DB, while Partner B has good DC returns. At the end of year 3, they are back to having equal PVAB's net of the offset.

So, in years 1 and 3, they had equal cost allocated, but year 2 partner B had increased costs assigned to him. However, the have equal PVAB's after year 3 remember. Oops.

What would you do here?

[Dougsbpc]

Of course the big wild card is the required interest rate used to determine lump sum distributions. If one partner leaves early, is younger and the rate is low, he/she will get a windfall and the remaining partners will get a haircut.

Question: as long as you have a small non-pbgc plan that has existed at least three years, is there anything wrong with the partners agreeing between themselves to terminate the plan if one partner leaves? The idea being they may be able to allocate any excess assets in a way that may allow benefits to closely match what was "contributed" over the years. This of course only if any excess assets are allocated in a non-discriminatory manner. They could then adopt a new plan in the next year.

[Dougsbpc]

Blinky

I try to convince those with floor offset plans to pool the employer contribution that is used for the offset. If they are not willing to do that then they may be stuck as you indicated. If you have a 40(k) plan, convince them to self-direct salary deferrals and pool the profit sharing.

[Belgarath]

As I've stated many times, I'm not a DB person, so much of this discussion is arcane to me. However, it struck me that I'd seen something on this recently. Apparently, this question was brought up in some manner at the ASPPA conference. I've enclosed the following from our EA's personal notes - it doesn't say much, but it might direct you to check with someone who attended the conference, or perhaps point you toward a lecture, session, comment from the podium? Sorry I can't provide any more info, this is all I have!

"Deduction for a partner is not the allocation he receives but his distributive share of partnership income. Unless there is a special allocation in the partnership agreement."

[tymesup]

And that last post is an example of where a large disconnect begins in assigning cost under the funding method versus assigning truer costs. For example, under IA a benefit formula funding 10% of Hi-3 per year of participation will cause a relatively low normal cost for someone 20+ years to retirement versus someone within 10 years.

I know of nothing that requires costs to be allocated in anything but a reasonable manner. Of course I believe it to be much more reasonable to allocate the cost much differently than what the funding method produces. Any different approaches?

I wouldn't be comfortable using IA over 20 years if the benefit is accruing over the first 10. Note that IA generally funds faster than the benefit accrues.

[tymesup]

I worked on a large law partnership plan some years ago. The assets were commingled.

We kept track of each partner's assets, subtracted them from that year's PVAB and the difference was their contribution. We then did the overall valuation and hoped it's range surrounded the total of the individual contributions.

Since the asset return jumped all over the place and the PBGC rates jumped all over the place, the partner contributions jumped all over the place. Partners were constantly asking why their contribution went up or down or sideways and why it didn't compare to the partner du jour. The arrangement lasted about five years before we were sent packing.

[Guest KennyH]

Let me throw a wrinkle into simply basing it on PVAB's with a more complex plan design. A good example of how PVAB's can get screwy is with an offset plan.

Say there are two partners of the same age, compensation and benefit formula, thus equal PVAB's without considering the offset.

Year 1: costs are allocated on PVAB's - no issue

Year 2: partner A has tremendous DC returns and thus has a reduced DB. Partner B is the opposite with very poor DC returns and an increased DB. Partner B is allocated a higher amount than A.

Year 3: this time partner A has poor returns and an increased DB, while Partner B has good DC returns. At the end of year 3, they are back to having equal PVAB's net of the offset.

So, in years 1 and 3, they had equal cost allocated, but year 2 partner B had increased costs assigned to him. However, the have equal PVAB's after year 3 remember. Oops.

What would you do here?

First, I would advise them not to have an offset. This is a poor design for this group of participants and unnecesarily increases the adminstrative costs, particulalry if they are interested in level contributiions. A separate DC plan coupled with a level % DB plan funded with EAN - level % of salary would probably work better. Of course I don't know all of the details and their goals regarding final retirement benefits and contribution levels have a significant affect on what is appropriate.

[Blinky the 3-eyed Fish]

First, I would advise them not to have an offset. This is a poor design for this group of participants and unnecesarily increases the adminstrative costs, particulalry if they are interested in level contributiions. A separate DC plan coupled with a level % DB plan funded with EAN - level % of salary would probably work better. Of course I don't know all of the details and their goals regarding final retirement benefits and contribution levels have a significant affect on what is appropriate.

Ok, forget the design aspect, I provided the offset example as a means to show that basing costs on PVAB doesn't work necessarily.

As an aside, I don't think you should blanketly state that offset plans are a poor design. It actually decreases administrative costs if the plan is PBGC covered by saving premium payments and distribution costs if the staff can have their entire DB benefits offset and just get DC contributions. It too decreases staff costs as DB contributions generally are worth less for gateway and nondiscrimination purposes. Doug's comment about a pooled PS account is right on the money. Also, I wouldn't propose designing anything other than UC since you have to use that next year, so scrap EAN. I too would scrap EAN in a partnership without PPA coming as you can easily skew results like I described with IA in a previous post.

But I digress and still am looking at what people think about allocating costs.

[Mike Preston]

For some reason, people are ignoring Belgarath's comment. In a db plan sponsored by a partnership, the individual partners are allocated a share of the entire plan cost by the partnership agreement. It has nothing to do with what each participant's accrual might be. Unless the partnership agreement has a clause in it that ties it back in some way. This is not for those with weak constitutions. Anything else just doesn't work, as far as the IRS is concerned, and is subject to being reversed upon audit. A partership DB plan, if not handled properly, is an IED.

[AndyH]

Mike, do you know how a law firm might be structured in this respect? I need to do a CB illustration for a large law firm. I don't know the structure right now but since it has "partners" I presume it is either a partnership or a LLC electing to be taxed as a partnership. Reasonable guess? Would an agreement typically govern the allocation of costs in such a scenario, even before the plan exists?