Currently with a solo-401k; does it make sense to add cash balance plan?

[xilex]

Hello, I am a 1099 independent contractor who has incorporated with an S-corp (one person/employee, which is myself). I've set up a solo-401k in order to make salary deferrals and employer profit-sharing (up to 25% of employee gross pay) to maximize the 55,000 contribution limit. This solo-401k is currently with Fidelity.

Recently I have learned about the cash balance plan. I thought I could just open an account at a place like Schwab, which offers a Personal Defined Benefit Plan, and be able to contribute some amount each year. I am aware this amount is based on age (currently 32 y/o). Upon some other discussions online, it sounds like the total contributions (401k salary deferral, 401k employer contribution, cash balance plan) may not exceed 31% of payroll.

If my annual 1099 income is somewhere in the range of 300-400k, would it make sense to consider adding a cash balance plan? I haven't been able to find clear-cut answers to this. For example, from this calculator (https://www.dedicated-db.com/defined-benefit-plan-calculator/) with a 350k income, I can only do 401k salary deferral of 18,500, 401k employer 6% contribution of 16,500 (not profit-sharing), and the defined benefit contribution of 33,400, which is only 68,400 so not really worth it.

My goal is to save up at least 120k annually in these accounts. With Schwab, it would cost $1500 annually for their plan. Someone suggested I find a full service provider to manage both my 401k and cash balance plan to ensure everything is in order. Would these companies run numbers for me and let me know if it's worth it or how much I would realistically be able to contribute?

Thank you.

[figure 8]

Note that the percentage limits aren't as simple as they may seem for 1099 income. You have two options when you have a PS and CB plan - keep your PS allocations to 6% of income and contribute whatever the CB plan allows, or keep your PS+CB allocations to 31% of income (well, and you still have the 25% limit for PS). You just have to be within one of these limits each year on your taxes. However, note that your 1099 income gets reduced by your retirement plan allocations for this purpose. So there are circular calculations going on, because as you contribute more, your compensation used for the limits goes down.

I'm sure there are probably plenty of companies who will run numbers for you and give you some advice. Companies that offer retirement plan services and actuarial services would be the places to look.

[xilex]

Thanks for the reply. Yes, I think I'll have to speak to someone who provides these services to give better numbers. It looks like there are many variables to consider that can complicate things.

[Larry Starr]

xilex:  First, you should stop thinking "cash balance" and just think  "defined benefit" plan. Cash balance makes very little sense in a one many situation; cash balance is just a particular formula that is used for a defined benefit plan but it has additional complications that a one man situation doesn't need to deal with.  The real advantage of a cash balance plan is the ability to put in different amounts for different owners or partners and keep track of those amounts. If you are a solo, that is a non-issue.

Plus, a defined benefit plan is NOTHING like the 401(k); you have fixed commitments and required funding that you do not have with your 401(k).  If you income is variable from year to year, you can easily get into difficult situations that require funding when you don't have the funds to meet the funding obligation.

This is not DIY plan design.  You absolutely need to talk with someone who knows this business inside and out (that isn't Fidelity).

And while a lot of people may not say it (because they always like to set up additional plans), yes, I would say you are too young to effectively utilize a defined benet at this point in your career.

 

[figure 8]

I respectively disagree with a couple of those comments.

1. I prefer setting up cash balance plans vs trad'l DB plans for one-person plans. Cash balance plans are so much easier than trad'l DB plans, in my opinion. You can keep things simpler and more predictable with a CB plan with a flat interest rate than by setting up a trad'l DB plan. There are very few situations where I'd opt for a traditional DB over CB. Personally, I would charge the same thing for either plan, but I have a bit of a dislike for the trad'l DB.

2. The 415 DB contribution limit for a 32 yo comes out to be around $65k or so . If you're looking to put away as much as possible for a) future retirement savings, and b) immediate tax deductions, then why not set up an additional plan?

I'm particularly curious what the "additional complications" of a CB plan are.

[Mike Preston]

There is just so much to disagree with I hardly know where to start.  How long have you been doing this to your one person clients?  Up until right about now (actually in about 2 months) all cash balance plans have been individually designed.  Why in the world would you put a client on an individually designed plan when that isn't necessary?  You mention flat interest rates, but you don't specify 5%.  This is a common error.  Use of anything other than 5% results in reductions to Section 415 lump sums. Why would a one person plan opt for a design that reduces the maximum deductible? As far as the 65000 you mention, I don't have time to check that at the moment, but since DC annual additions are use them or lose them most clients will shy away from any DB plan in their 30's unless they can establish with reasonable certainty that they are in the last 10 years of income generation (sport's figure,  for example).  Otherwise they are trading $100,000 to $200,000 deduction years for $80,000 deduction years.  Yuck. 

[figure 8]

For quite a few years now (ever since the IRS made it clear that they intended to eventually get around to pre-approved cash balance documents) it's been perfectly acceptable to draw up a cash balance document (using FT William or Datair whatever other standard document vendor you might want to use) and have the client fill out a Form 8905 (intent to adopt pre-approved document once the IRS make them available). This requires no determination letter. This requires no extra fee than a trad'l DB document would cost (not from me at least). The only extra thing you have to put the client through is an extra signature (signing the Form 8905). Is an extra signature really that bad of a thing to put a client through?

Regarding the timing of starting up a DB plan - I'm not saying everyone should start maxing out in their 30s. I'm saying - if that's what someone wants to do for whatever reason they have - what's wrong with setting up a plan? Yes, you can't deduct as much in your 30s as you can in your 60s, but at least you get 30 years of tax deferred investments. There could be all sorts of reasons for starting a plan in your 30s. Maybe someone intends to be on their own for the next 10-15 years before going to work / becoming a partner at a different firm - at which point, they could end up taking advantage of a second DB plan. To simply say - nah, you're in your 30s, you don't want to do this - doesn't seem helpful. It seems better to get a fuller story and make sure the client understands the implications for the present and future, and let them make their own decision.

Also, I don't agree on your 5% comment, and I'm going to gander that most actuaries who work heavily with cash balance plans would disagree as well. At least, that would be my guess judging from all of the webinars I've seen, takeovers I've seen, and just generally talking to other actuaries at different firms (as well as my own understanding of the 415 calcs). However, I do believe that after age 65, a rate smaller than 5% would create a lower 415 limit. But that's not what we're talking about here.

Mike, you sound like someone who takes an extremely conservative approach to this. Which is perfectly fine if that's what you want to do. But please understand that not everyone in the industry is like that, and I have full confidence with my approach here.

[Swoosh2123]

I have a few comments about this thread:  

1.  I agree with figure 8 about CBPs being the preferred DB plan type now that the IRS has come out with pre-approved plan documents.  We stopped doing traditional DBs as soon as they started allowing 8905s for the exact same reasons he did.  Using a traditional DB plan these days is making it harder for clients who don't make maximum income no matter what like the person in question.  He could have a formula in a CBP that is dependent on compensation like 10% of pay up to $150k plus 900% of pay over $150k  or something like that to allow him maximum flexibility.  While that can theoretically be done in a traditional DB as well, it's much more difficult.  

2.  The interest crediting rate in a plan like this doesn't really matter.  Why not pick 5%?  In my opinion, there is no reason not to.  But I also agree with figure 8 that choosing something lower only matters if the participant ever gets to be over Age 65.  But still, asset return is such a small part of the minimum required contribution calculation, that we recommend 5% to all of our clients with no employees.  

3.  Regarding the timing of setting up a CBP, we recommend the following scenario for our young clients.  Max out your profit sharing first because it is a use it, or lose it deduction.  Contribute whatever is left in the 31% limit into your cash balance plan.  If making maximum compensation, that's still just under 18% of pay (about $48,750).  There is no need to limit profit sharing to 6% yet.  After 5 or 6 years of running the plans that way, the plan sponsor can switch and start making 6% profit sharing contributions and much larger CB contributions for the last 4 to 5 years when the participant is older can take advantage of the prior years of participation available due to not maxing out for the first 5 or 6 years.  

4.  At the end of the day this poster should consult two very important people.  First, his accountant to see how much of a deduction will even be helpful based on his entire tax situation, new tax law, etc.  After he has done that and determined how much to contribute, he should talk to an actuary who specializes in small company plan design.  While it may cost slightly more than a cookie cutter DB outfit, it is definitely worth the extra $500 - $1,000 per year.  

[Mike Preston]

So you want to explain to the heirs that an unnecessary A&R is required because you recommended a CB plan when a traditional plan was available?  And who wants to explain "Well, you are now older than 65 so our plan design has reduced your 415 limit unnecessarily." And not to be picky, but have you heard about the obsolescence of 8905?  There are just so many things wrong with a one person plan being set up as a cash balance there isn't the time to delineate them all.  Peace to all, one way or the other.

[figure 8]

No offense Mike - but again, you're coming across as someone who takes an extremely conservative approach to this. And we addressed the post-65 issue. I feel strongly that a trad'l DB plan is inferior to a CB plan in almost every situation I come across (including a one person plan). I understand that you disagree. It'd be nice if you could disagree without implying I (as well as the other actuaries who do this) do things wrong. Peace.

[Mike Preston]

We didn't address the post-65 issue.  Somebody said it wasn't a big deal.  It is.  To say it isn't is to say that 415 isn't a big deal.  I don't consider it being conservative.  I consider it doing what is best for the client, not only for the client that walks through the door, but also those that might be impacted (heirs, future employees, future partners, etc.).  You haven't addressed what you say to the heirs.  The absolute best thing about CB plans is exemption from 417e.  Tell me how that matters to the 1 person plan?  Be honest.  If the absolute best thing associated with CB plans doesn't amount to a hill of beans, can you start to see the issue? 

[figure 8]

Swoosh and I both mentioned that a rate below 5% will negatively impact someone's 415 limit past 65. So use 5% if that's going to potentially come up. No one's disagreeing with that.

I would say to the heirs that same thing I would say to the heirs of a trad'l DB plan. I don't understand what you're saying about an unnecessary A&R. To me, that's something that someone with an extremely conservative outlook would say. Have you ever heard of this happening?

I disagree the best thing about CB plans is the "exemption from 417e." That's one thing. Also, they're just easier to appropriately design and they're simpler for the client to understand.

I have been honest, and I do not see the issue.

[Swoosh2123]

Mike Preston, you seem to be arguing about what should have been done in the past for owner-only plans, but this poster is considering adopting a plan for 2018.  Now that we have pre-approved plan documents for CBPs exactly the same as for traditional DBPs, (no additional expense or risk) why would this person ever choose a traditional DB plan over a CBP?  You are ignoring the biggest benefit of a CBP for an owner-only plan.  The ease of understanding for the single owner.  The lack of 417(e) is an additional bonus as well.  

Since the traditional DB has absolutely zero advantages over a CBP on May 8, 2018, why would anyone ever set up a new traditional DB plan?  It seems like you are on board with that thought, but maybe I'm wrong.  You can let us know what you think the advantage of a DB plan is if this person adopts a plan on a new pre-approved document with a 5% crediting rate.  If you don't have one, then I think we all need to move on and agree that new traditional DB plans are dead and this person should adopt a CBP when his accountant says he is ready for larger retirement plan deductions.  

And I came up in the traditional DB world so it's not like I have anything against them.  I'm still hoping that when the job market again becomes employee-driven instead of employer-driven, employees will come around and realize they want a monthly annuity stream in retirement from their employers.  Until then, the CBP is the defined benefit plan of the present and future for companies of all sizes for good reason.  

[NJ Mike]

I agree with Mike Preston.  I have never and will never put in a cash balance plan for a one person plan.  I don't care about the document stuff, that has no bearing on this.  I have put in  a DB plan for a couple of clients in their late 30's or early 40's.  I explained the consequences to them but they felt it fit their situation.  But that's maybe 2 or 3 plans in over the 35 years I've been doing this.  Two plans are fine when they benefit the client.  Mike 

[figure 8]

I'm guessing that the longer one has been in this industry, the more likely they are to stick with trad'l DB in certain situations. Which is perfectly fine if that's what you want to do. My only issue at this point is being accused of doing things wrong. I will defend that. Otherwise, it seems like it mainly just comes down to opinion and personal comfort level.

[Mike Preston]

Sorry, selling the client a fancy new bauble that turns out to be something other than a genuine gemstone is frowned upon by most.  Claiming that clients understand CB plans better than they do traditional DB plans is just plain wrong.  Among many other things, clients will never understand that the super integrated formula referenced earlier generates a hypothetical account balance well in excess of the 415 limit. And it will almost always be simpler to get where you want to go in a traditional DB plan other than plans which are designed to provide benefits less than the 415 limits and otherwise act as super DC plans.  Most of my one man plans are interested in two things: funding flexibility to the extent possible and accruing maximum benefits in good years.  A traditional DB plan makes it easy to provide both, and up until the VS document providers actually publish a pre-approved plan, don't expose clients to a death tax of sorts for the strongly recommended A&R.  If you don't understand what I'm talking about I've made my point. If you do understand my point and hold to your position why are you exposing your clients like that?

[figure 8]

I understand perfectly. I shall now get off your lawn.

[Larry Starr]

I started all this when I said there was no reason for a cash balance in a one man plan.  I do still stick with that but I have let the prior posters battle it out.  Just so it's clear, I agree with Mike Preston 100%, and not because he (and his wife) are dear friends of mine (and my wife), we have traveled together around the world, and he has been my partner in some ventures over the years that were for the benefit of the industry.  If I didn't agree with the philosophy, we would argue to the death! But I do agree.

The one thing I wanted to comment on is this comment: "You are ignoring the biggest benefit of a CBP for an owner-only plan.  The ease of understanding for the single owner."

Sorry, but that's just nonsense. They don't understand the DB plan and never will (either the CB or the traditional). All they know is how much money is in the plan and that it's all theirs, and how much they can afford to contribute in any one year (which, as we all know, can wildly fluctuate in many one man plans).  Beyond that, they are completely lost and it is our solemn duty to keep them within all the boundaries that are place on DB plans and accumulations and legal restrictions.  That's what we do routinely; and that is our most important job here.

[figure 8]

Eh, I don't know. I've come across owners with no employees who can grasp the basic concept of the CB and have a general understanding of how it works (including one man plans). They obviously don't have the actuarial knowledge of the behind the scenes rules and details, but they can see something like  " hey my CB allocation is X each year; that matches what I contribute." The design clearly lines up with the expectation, whereas almost no owner is going to have a clue what a $1750 accrued benefit means in terms of an annual contribution.

Let's face - it doesn't really matter that much though, because for an owner-only plan, you're basically right - they generally just care about the money being all theirs and that they can contribute what they want to contribute. Which is why I still stand by doing CB plans for one-person plans. It doesn't really matter to the typical owner-only client what plan you do if there's no practical extra cost or risk to them, and so I'm going to do what I feel is simpler and what I'm more comfortable doing - CB. I just feel like CB plans are superior, and that opinion doesn't change based on participant count size.

I do agree with you on our most important job though (keeping them within boundaries, knowing the rules, etc). Really the only reason I've been arguing in this thread is because I feel like I'm being told I'm doing something wrong. I take a lot of pride in my work and do what I feel is the right thing. I try to do a good job (and feel like I do), so I'm not going to take too kindly to that criticism. Whatever happened to just agreeing to disagree?

[Bob the Swimmer]

Very interesting thread and I credit both sides for their careful thoughts conveyed. 

I have a single person DB plan and it is a great thing for my advanced age. Not sure whether starting a CB at 53 would have produced a higher result today 13 years later than my current accrued benefit, but it's an interesting thought, and maybe not because we have never been overly-aggressive, my actuary and I.

BTW, I've never in 42 years of consulting had real trouble either communicating a DB or a CB to a single-person owner--client effectively.