Cash Balance Plan Funding and IRC 415

[mwyatt]

Don't do very much with cash balance plans, so a little curious about some of the proposals that I see across my desk. Have a proposal in hand that is showing seriously high cash balance additions for a group, and want some thoughts.

Participant Age 39, NRA to be 65 (not sure why they didn't go with 62), salary of $230,000, interest accumulation rate of 6%.

They are showing a first year annual credit of $170,000 for the participant. Now if I value 1/10th of the dollar limit using the 2008 417/415 Applicable Mortality Table at 5.5% (with no pre-retirement mortality), I get a current present value of around $52,800, which seems to be a little bit of a discrepancy compared to a $170,000 allocation.

What am I missing; seems that this type of credit is way beyond the 415 limits to me.

[rcline46]

If the proposal is from an actuary, they should be willing to disclose their assumptions. If not from an actuary I would have serious problems with the plan as it would be greatly overfunded subjecting the sponsor to some nasty (50%) excise taxes on reversions.

[david rigby]

Reversion excise taxes are not the first problem. 404 is the first concern, along with 401(a)(4).

I also doubt that $170K is correct. Perhaps there are facts not yet in evidence. For example, could the $170K be the principal's "allocation" of the total contribution, including other non-principals?

[mwyatt]

The $170k was for the individual participant (also several other older doctors, who I could more reasonably see this being OK given their ages, but guys in their mid 30s makes that hard to believe).

Wouldn't you be capped in any given year of a CB allocation to the CB equivalent of the 415 accrual allowed during the year?

[SoCalActuary]

The $170k was for the individual participant (also several other older doctors, who I could more reasonably see this being OK given their ages, but guys in their mid 30s makes that hard to believe).

Wouldn't you be capped in any given year of a CB allocation to the CB equivalent of the 415 accrual allowed during the year?

You are capped at the maximum benefit available for distribution. You are capped at the maximum benefit you can fund to.

So a hypothetical allocation of 3 x the current 415 limit could be written in the plan, but it can't be paid nor funded.

[Blinky the 3-eyed Fish]

I guess seriously overfunding CB plans is the new 412(i).

[mwyatt]

Guess the 419 and 412i purveyors have moved on to bigger and better things (one thing that does befuddle me is that they don't realize traditional DB plans can also offer lump sum payments).

[JAY21]

I think this proposal does illustrate the challenge that even with a cash-balance plan it's still tricky to give all the target group (e.g., doctors, or owners) the same contribution given differing 415 limit present values.

I've struggled with it myself where to design the uniform pay credit for a shareholder group IF they all want the same contribution. Do you pick a shareholder in the middle range of the ages to design the pay credit around with the expectation that the younger shareholders who initially get a theoretical pay credit greater than the PV of their 415 limit will "grow into" the pay credit via future COLAs on 415 limits, YOPs, and increasing PV as they age.

I know that one selling point of CB plans is the uniform allocation availability for shareholders but someone isn't going to be too happy when they get a theoretical allocation of 100k then decide to leave the group and get 52k as a distribution. I like the combo plan approach best when the shareholders get their 46k in DC plan and maybe the group will be satisfied then with say an additional 50k in the cash-balance plan (i.e, something less than the youngest shareholders 415 limit).

[mwyatt]

Really stupid question here, but here goes:

In our example, we have a 39 year old doctor getting a $170,000 hypothetical allocation. For sake of argument and simplicity, let's say we have this 6% interest crediting rate, and that our conversion factors under the document are the 2008 Applicable Mortality Table at 5.5% interest (factor at age 65 would be 137.855). For PPA purposes, let's say our applicable segment rate is 6.09%.

This is the first year of the plan, so I need to determine the Target Normal Cost for this individual.

Assume interest is credited at end of year, so my projected accumulation at age 65 is:

$170,000 * (1.06 ^ (65-(39+1)) = $729,618.

I then convert this to an annuity form to $729,618 / 137.855 = $5,292.65 monthly SLA.

I then calculate PV of this using my PPA funding assumptions to get the target normal cost for the individual (one possible interpretation, based upon a reading and discussions at the EA Meeting, is I could use what I expect lump sum to be paid at to determine PV @ 65, namely 415 limits on lump sum of 2008 AMT @ 5.5%, then discount on interest only since small plan ignoring pre-ret decrements), so

TNC = 5,292.65 * 137.855 * (1.0609 ^(39-65)) = $156,877.

My question is this, thinking about this proposal; TNC is supposed to be measuring the benefit accruing during the year. I would presume that IRC 415 would need to be applied in this situation for TNC purposes, so instead of funding to $5,292.65, I would have to be capped at the dollar limit * 1/10 or $185,000 /12 * 1/10 = $1,541.67, or I think that I would have to be in some violation by funding a benefit accrued in 2008 clearly well in excess of IRC 415. So in that case my TNC, regardless of the hypothetical accrual, would be

TNC = 1,541.67 * 137.855 * (1.0609 ^(39-65)) =$45,694.

Am I correct in this analysis on the 415 issue? If so, seems kind of silly to pretend in the first place that this guy should be credited within anything near the $170,000 mark.

[Blinky the 3-eyed Fish]

I didn't check your math or your APR, but what you say appears to be correct.

[rcline46]

I agree with myatt. I cannot believe that you can fund the ENTIRE 415 benefit in one lump sum today, which is what the $170,000 shows based on myatt's calculations.

[mwyatt]

So to cut to the chase, despite what any allocation purports to be, you aren't going to actually fund in real dollars the supposed account balance if the equivalent benefit is over the IRC 415 limit allowed through the end of the year of funding? Didn't see that anywhere in the proposal sent to me (and I think that the client would probably be more interested in the actual dollars going in rather than what some statement says he has - I know I would).

If this group just set up a traditional DB plan providing for 415 maximum accrual each year, you're going to end up in about the same place in the PPA world (and with the ability to have older partners get a larger contribution). Otherwise, seems that if you want to use the "all for one, one for all" approach to the HCE allocations, what you really have to do is set your allocation amount to the 415 equivalent of the youngest partner. Not sure if that makes much sense.

[Mike Preston]

Shot in the dark, here. Any chance this individual is really participating in a DB plan where the number of years of plan participation are something other than one? Maybe a past DB plan where he has 6 years of participation, but a small prior benefit? While it would be hell on the general test, such a large "catch-up" funding is theoretically possible.

[mwyatt]

Hope that you would chime in Mike. Nope, brand new plan proposal (only have a safe harbor 401k plan in place now for the group).

Cash balance seems to be the buzzword now among brokers and agents; I've talked to some and they are amazed that regular defined benefit plans can actually offer lump sums. In the small plan market, when we also go over the fact that the startup costs would be significantly higher due to the individually designed aspect of the plan document (and accompanying doubling of document fees plus the $1k user fee to the IRS) v. the ability to use a Volume Submitter or prototype document with a regular DB plan, we can then steer them over to a regular defined benefit plan and pretty much accomplish what they're trying to get in the first place.

Seems to me that if this group really wanted to do cash balance for the equal contribution aspect, that they would have to bring all of the partners back to the least costly (i.e., youngest) partner's contribution level for it to work out. Kind of cuts the attractiveness out of the equation since the older partners are then way limited in what could be contributed on their behalf.

[tymesup]

Any possibility they allocated the total contribution by compensation? And/or funded 150% of the Funding Target?

[mwyatt]

Don't believe so, but still left with the fact that Mr. Young Doctor is believing he has $170k in his account. Wouldn't want to be the one explaining that a couple of years down the road after he decides to go out on his own.

[tymesup]

There may very well be an account with 170K in it, which Dr. Doctor may even be directing. Heck, if he's a Trustee, who's going to stop him from distributing these assets?

I once inherited a DB plan with three owners in it who were putting in the same amount because the Individual Aggregate normal costs were the same. When Ms. Old Owner left, she took 1/3 of the money - about 200K. Because she had two extra years of accrual by the time she left and 417e rates were much lower than the valuation rate, she was entitled to something north of 800K. Maybe we should put her in touch with Dr. Doctor.