Owner[solo] contributes $100k to DB Plan and immediately withdraws and pays taxes onit

[CharlesLeggette]

This plan is part of a group of plans I’ve been asked to take over from a life actuary who is also an EA.

The one employee/owner has ample income to take care of 415(b)(1)(b)…he’s doing this to escape state SE and Federal SE taxes.

He’s a corporation.

He’s still actively employed.

Prior actuary certified it for 2012, 2013.

EOY val.

For starters, The AFTAP flunks—less than 60% because the plan has no assets at EOY, so benefit restrictions kick in.

I know of no waiver for a 1 person plan for the 436 benefit restrictions….maybe there is one…

The pension formula doesn’t match up with the $100k in and $100k out….

I guess you could design a DB formula that would have an annual accrual the cash lump sum of which equals $100k and have him take in in-service distribution for $100k, but I haven’t investigated how that will affect the AFTAP.

Has anyone ever done this before and does anyone see any possible solution to this – forgetting for a moment the seeming sham nature of it and prior years’ AFTAP certs that were wrong.

Thoughts would be appreciated,

[Effen]

More information is needed.

How does he justify taking all of the assets out at the end of the year? Is he over NRA? What is the distributable event?

Is this a cash balance or a traditional db? Can you give some idea of the benefit formulas.

Can you provide more specifics around the entry age, attained age, and retirement age of the participant.

[CharlesLeggette]

How does he justify taking all of the assets out at the end of the year? Is he over NRA? What is the distributable event?

Yes he is > 65.Plan has an In Svc distrib provision.

Is this a cash balance or a traditional db? Can you give some idea of the benefit formulas.

Traditional DB --100%of pay.

Can you provide more specifics around the entry age, attained age, and retirement age of the participant.

Had the Plan since 2012...doing the 2014 EOY val.

[Effen]

So, was the prior actuary just determining the value of his current year's accrual and telling him to contribute that. Then he takes it out as a distribution equal to the PVAB? Were you just rounding when you said he puts in 100K, and takes out 100K?

I guess IF the plan had an in-service distribution option, and if the PVAB of the current year's accrual fell within the min/max for the plan year, you could contribute the PVAB, then turn around and immediately take it out as a lump sum distribution.

I am not a tax pro, but seems to me you are not accomplishing any different than taking it as compensation. Corp gets same deduction whether it pays the pension contribution or payroll, participant takes it right out and pays the income tax...so what have you saved?

Except, by doing it this way, the money is never taxed for social security or medicare? Interesting....I guess if your comp was high enough, it might justify the cost of the plan.

[mbozek]

What happens to the 100k distribution? If it is rolled over to an IRA then there is no tax except for the portion that is a MRD at 70 1/2.

[CharlesLeggette]

The entire 100K is rolled...he's not 70 1/2 yet.

[mbozek]

I am going to leave the nuances of DB plan requirements to the actuaries but from a tax perspective if the contribution under IRC funding rules is 100k and value of the accrued benefit for that plan year is 100k then he can roll the 100k over to an IRA tax free and claim a tax deduction of 100k. See IRS pub 560 P 15-6. DB plan contributions are based on actuarial assumptions and computations. At 70 1/2 he must commence taking mrds equal to at least 3.65% of the account balance at the end of the prior year.

Participant saves the 15.30% FICA/SECA tax or $15,300 on the $100k contribution in addition to the income tax deduction.

[My 2 cents]

1. There may be some issues with the AFTAP being low. If below 60%, would there be any accrual at all? Would it be permissible to allow payment faster than under a straight life annuity?

2. Are there any other people covered by the plan? If so, it might be necessary to worry about 25-high restrictions.

3. Can it be clearly established that the contribution has the same value as the benefit to be distributed? That would normally not be the case,but I am not sure how 1-person cash balance plans with a participant past normal retirement date come out.

4. If the participant has more income,then the "special treatment" being given to the plan contribution and distribution might not save as much as $15k in FICA/SECA taxes. And I am not sure how these things work together for FICA/SECA tax purposes. Are the taxes due based on a pre-deduction earnings basis?

[Doghouse]

In a prior position, we had a plan exactly like that, and for exactly the same reasons. However, once AFTAPs hit the scene, it got ugly. We ended up terminating it. I never liked it anyway, it seemed a bit too blatant in its obvious purpose of avoiding Social Security taxes.

[david rigby]

Pays taxes on it? Not rolled to an IRA?

At $100K, he is saving $2,900 in FICA taxes. Seems not cost-effective, even if the ATAP comments above are ignored.

[tymesup]

Leave a dollar in the plan. The AFTAP is 1/0; the funded percentage for 110% rule is 1/0.

[Calavera]

I am ignoring the legality of $100k-in / $100k-out scheme, and only discussing the AFTAP.

I am not sure if there are any AFTAP issues from the 436 benefit restrictions perspective. AFTAP for EOY val is (MVA + Contribution)/(TL + NC). So you have MVA=$0, Contribution =$100k, TL=$0 (assumed) and NC for the minimum funding purposes probably below $100K (since $100K satisfies the minimum contribution with interest). This will give you AFTAP over 100%.