Funding a Plan with a bank loan

[Guest Zippy]

My company has a DB plan with about $350k in assets. We'd like to terminate the plan immediately but are about $200k short of what's needed to do that. We intend to fully fund the plan over the next 3-5 years and terminate it as soon as possible.

Unfortunately, PBGC premiums ($3800 this year alone!) administrative/filing costs, property taxes and the annual surety bond for the plan's real estate holdings mean that we pay $12k-15k annually in administrative overhead, far more than the investments earn in the current environment. It seems to me that it makes more sense to borrow the money from the bank to terminate the plan now. The interest we'd pay would be about 1/3 of the administrative costs, we'd be free of the reporting burdens and would have this monkey off our back for good.

Does this sound practical? We have some assets we could use to guarantee the loan, and I assume our plan contributions would still be tax deductible?

Thanks in advance.

[SoCalActuary]

Is it good tax planning? Are you borrowing money to convert into benefits that will be paid as ordinary income?

Will the deduction help?

Is this a good use of capital?

[david rigby]

... the plan's real estate holdings ...

No matter when the plan is terminated, plan assets must be liquid.

[SoCalActuary]

... the plan's real estate holdings ...

No matter when the plan is terminated, plan assets must be liquid.

Normally I agree, but there are exceptions in the microplan market, where the sole participant agrees to take distributions in kind.

This is especially true when the plan is terminating with assets rolled to a replacement or other DC account.

[Guest Zippy]

... the plan's real estate holdings ...

No matter when the plan is terminated, plan assets must be liquid.

Thank you for your responses.

We plan on selling the real-estate. Nothing could happen until then.

I guess it comes down to whether the tax benefits outweigh the expenses. Between the DOJ audit we just went through and the ongoing administrative fees, I'm inclined to want to get out of it at any cost. With a loan at least I'd know up-front what the costs will be. The way it is, with PBGC premiums escalating every year, annual filings, regulation changes requiring plan restatements, etc. etc. I may as well have given our plan administrators a blank check.

Our CPA at the time talked us into a DB, and it was to biggest mistake we ever made.

[Bird]

I think you've analyzed it well - you're basically swapping one debt for another, and saving a whole bunch in expenses.

There is at least some possibility that an increase in the interest rate environment could reduce the value of benefits, but I would guess that is minimal and not worth just hanging on for another couple of years. (I don't know much about valuing DB present values any more so I could be off base.)

I suppose there is also some possibility that your company could go bankrupt and foist the unfunded benefits onto the PBGC, but that seems pretty unlikely, and again, I don't know enough to say whether that is a real possibility or not - just brainstorming a bit to help you cover all of the possible outcomes.

Our CPA at the time talked us into a DB, and it was to biggest mistake we ever made.

Yeah, I have a pretty serious heart-to-heart before we install a DB. CPAs do this thing where they look at the contributions for the non-owners and look at the tax savings for that and say "well it only costs you X" and it's too simplistic for my taste.

[mbozek]

... the plan's real estate holdings ...

No matter when the plan is terminated, plan assets must be liquid.

Thank you for your responses.

We plan on selling the real-estate. Nothing could happen until then.

I guess it comes down to whether the tax benefits outweigh the expenses. Between the DOJ audit we just went through and the ongoing administrative fees, I'm inclined to want to get out of it at any cost. With a loan at least I'd know up-front what the costs will be. The way it is, with PBGC premiums escalating every year, annual filings, regulation changes requiring plan restatements, etc. etc. I may as well have given our plan administrators a blank check.

Our CPA at the time talked us into a DB, and it was to biggest mistake we ever made.

Zippy:

Someone should post your last sentence on all of the blogs and web sites that are posting articles by air head accademics and investment managers on how governments should encourage creation of DB plans for employers including wacko proposals for states to operate DB plans for private employers (CA anyone?)

[Hojo]

In the micro market, DB plans should be see as long term benefits for employees, DC plans are short term tax shelters for employers.

[mbozek]

In the micro market, DB plans should be see as long term benefits for employees, DC plans are short term tax shelters for employers.

Just how many non owner employees ever receive a benefit from DB plans given that the average tenure of employees is less than 5 years which is the usual requrement for vesting. In any event, discounting the future value of the benefit reduces the present value available for a rollover to a few hundred dollars.

Problem with DB plan is maintaining sufficent funding levels to pay benefits on a long term basis given the volatility of investment returns and market crashes ever 5 or so years.

[Effen]

Ouch! I am feeling a lot of negative waves about db plans on the db board. We don't come on the 401(k) boards and talk about how bad 401(k) plans are for society.

Just like any other types of plans, dbs are not for everyone, but where they fit, and where they are understood, they offer a great benefit.

Obviously different markets and different types of plans, but in the micro market vesting is generally 3-yr cliff, or 6 year graded - just like the dc world. And I would point out that most money flowing into 401(k) is deferred comp, not employer money. Micro db plans are generally designed as tax shelters for selected individuals, just like micro dc plans.

We can debate pro/cons and all the social implications you want. Both types of plans have advantages and disadvantages, both types are often "sold" to people who don't understand what they are buying, both types have problem situations. Bad consultants produce bad plans. Where they fit, they can offer power tax advantages, however if sponsors can’t fund them, you end up with a bad situation.

[Hojo]

Ouch! I am feeling a lot of negative waves about db plans on the db board. We don't come on the 401(k) boards and talk about how bad 401(k) plans are for society.

Just like any other types of plans, dbs are not for everyone, but where they fit, and where they are understood, they offer a great benefit.

Obviously different markets and different types of plans, but in the micro market vesting is generally 3-yr cliff, or 6 year graded - just like the dc world. And I would point out that most money flowing into 401(k) is deferred comp, not employer money. Micro db plans are generally designed as tax shelters for selected individuals, just like micro dc plans.

We can debate pro/cons and all the social implications you want. Both types of plans have advantages and disadvantages, both types are often "sold" to people who don't understand what they are buying, both types have problem situations. Bad consultants produce bad plans. Where they fit, they can offer power tax advantages, however if sponsors can’t fund them, you end up with a bad situation.

Well said.

[frizzyguy]

Bad consultants produce bad plans. Where they fit, they can offer power tax advantages, however if sponsors can’t fund them, you end up with a bad situation.

I couldn't agree with this more. Also, if a plan is going to turn foul because of economic or demographic reasons, a good consultant should be able to see it coming and get you out before it's "the biggest mistake" you've ever made. Things happen from time-to-time in a business that has a DB plan and knowing how to manuver them is as important as anything when it comes to consulting.

[Lou S.]

Of course sometimes you can't talk a client out of that huge tax deduction their CPA says they just absoluetly need. Until the next year when you tell them the contribution is $X and they say "How come you never told me about these required contributions." and when you reply "you did and they acknowledged they understood that contributions would be substantial and recurring" then point to the 5 year projection you did for them when you set up the plan, they look at you like you're from Mars or something.

[Guest Zippy]

Of course sometimes you can't talk a client out of that huge tax deduction their CPA says they just absoluetly need. Until the next year when you tell them the contribution is $X and they say "How come you never told me about these required contributions." and when you reply "you did and they acknowledged they understood that contributions would be substantial and recurring" then point to the 5 year projection you did for them when you set up the plan, they look at you like you're from Mars or something.

Well, that was exactly our situation, except that our CPA didn't do projections and definitely left us with the impression we could contribute to it in good years and not in others, and that clearly isn't the case. I'm not sure the CPA knew himself, as he was primarily looking at the tax advantages. I can't imagine any case where creating a long-term liability like this (one requiring mandatory contributions) is a good idea for any company, as an organization's financial health years into the future can never be known.

The people who administer the Plan for us have their own interests at heart. We only get the information we need when we know the right questions to ask.

These days we do, but we certainly didn't when we signed on to this.

[Lou S.]

Well, that was exactly our situation, except that our CPA didn't do projections and definitely left us with the impression we could contribute to it in good years and not in others, and that clearly isn't the case. I'm not sure the CPA knew himself, as he was primarily looking at the tax advantages. I can't imagine any case where creating a long-term liability like this (one requiring mandatory contributions) is a good idea for any company, as an organization's financial health years into the future can never be known.The people who administer the Plan for us have their own interests at heart. We only get the information we need when we know the right questions to ask.

These days we do, but we certainly didn't when we signed on to this.

Well when it is created as an honest to god retirement plan for the employees and/or owner of the business it can make a whole lot of sense. When it is done because "we have some extra cash this year and we don't want to pay taxes on" it usually does not.

For what it is worth, defined benefit plans were once the norm in retirement plans. Unfortuantely many factor too long for this thread have conspired to make them something of a dinosaur.

Sorry you had to learn this hard way but it sounds like you've done some good work educating yourself on the issues involved. Good luck with whatever you decide to do.

[FAPInJax]

... the plan's real estate holdings ...

No matter when the plan is terminated, plan assets must be liquid.

Normally I agree, but there are exceptions in the microplan market, where the sole participant agrees to take distributions in kind.

This is especially true when the plan is terminating with assets rolled to a replacement or other DC account.

Note that there may be a problem with the real estate devalued and the owner the ONLY participant able to take potential advantage of the increase in the asset.

[Mike Preston]

People who invest DB funds in real estate are asking for trouble. Even the slightest bit of research would have told the OP that. This plan should probably not have been set up in the first place because the investments contemplated were probably better described as speculating.

Every db plan should have an escape plan in the event of bad things happening. Nobody planned for an escape when this plan was set in motion and that is a shame.

Is anybody else picking up on the fact that there was a Department of JUSTICE audit? Now, if he meant Department of LABOR audit, I can sympathize. But if it really was a DO*J* audit, my hairs are starting to stand on end.

Something sounds rotten in Denmark and I don't think blaming the DB plan makes any sense at all based on what we have been told.

It is very simple to design a DB plan these days to avoid cash flow problems and I'm sorry that the OP didn't have his plan design (including investment strategy) set up to do that.