FAQ

There are two general types of pension plans — defined benefit plans and defined contribution plans. In general, defined benefit plans provide a specific benefit at retirement for each eligible employee, while defined contribution plans specify the amount of contributions to be made by the employer toward an employee’s retirement account.

In a defined contribution plan, the actual amount of retirement benefits provided to an employee depends on the amount of the contributions as well as the gains or losses of the account. A cash balance plan is a defined benefit plan that defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance.

In a typical cash balance plan, a participant’s account is credited each year with a “pay credit” (such as 5 percent of compensation from his or her employer) and an “interest credit” (either a fixed rate or a variable rate that is linked to an index such as the one-year treasury bill rate).

Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks are borne solely by the employer. When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance.

For example, assume that a participant has an account balance of $100,000 when he or she reaches age 65. If the participant decides to retire at that time, he or she would have the right to an annuity based on that account balance.

Such an annuity might be approximately $8,500 per year for life. In many cash balance plans, however, the participant could instead choose (with consent from his or her spouse) to take a lump sum benefit equal to the $100,000 account balance.

If a participant receives a lump sum distribution, that distribution generally can be rolled over into an IRA or to another employer’s plan if that plan accepts rollovers. The benefits in most cash balance plans, as in most traditional defined benefit plans, are protected within certain limitations by federal insurance provided through the Pension Benefit Guaranty Corporation.

In theory it does not matter. When you are a sole proprietor, the defined benefit plan calculation is a more complex calculation that is based on your business income.

But for an S-Corp or C-Corp, it is just based on your W2. With a corporation, you have a little bit more control of your contribution because you can increase or decrease your compensation (assuming you meet reasonable compensation). It is easier for us to determine your annual contribution under an S-Corp or C-Corp structure. But at the end of the day, your business structure is between you and your accountant.

If you are a sole proprietor, then you will file a Schedule C with your personal tax return. You will not file a separate tax return. Your net profit is reported on line 31 of your Schedule C.

If you are an S-Corp or C-Corp, your net profit is determined after deducting your W2 compensation. For example, if your S-Corp has a profit of $300,000 before you pay yourself a wage of $100,000, then your business profit would be $200,000.

Unfortunately, there is no Roth option for these plans. Remember that the company will get a tax deduction for the contribution, so the employee must pay ordinary income tax once the money is withdrawn.

There is no defined period of time that your plan is required to be open. However, the IRS does consider these plans to be permanent. The IRS assumes the plans will operate indefinitely or at least for “a few years.”

The IRS regulations do not clearly define what “a few years” truly means. But generally speaking, the IRS has not typically questioned a plan termination that happened more than 10 years after inception. In addition, employers that terminate a plan within 5-10 years have normally not had a problem.

But if you want to terminate your plan, just make sure that it’s a business necessity. A business necessity would usually involve lower business profits, change in ownership, or an issue that restricts funding the plan. The IRS has even accepted the fact that a company adopted a different retirement plan as a valid reason to terminate.

There are a lot of business owners out there that want to set up plans to make large contributions. But they are concerned because they have employees and they want the plan to make financial sense. Since these are qualified plans, the IRS requires non-discrimination testing.

What this means is that if your employees are eligible and qualify you’ll have to make a contribution for them. But the goal is to minimize this as much as possible. Usually, we can make this work and exclude a number of employees.

For example, we can exclude the following employees:

* Employees under the age of 21

* Employees who work less than 1,000 hours a year

* Employees hired during the current year can be excluded based on plan entry dates.

The goal is that once you exclude the employees above and calculate minimum contributions, at least 90% of the total contribution goes to the owner.

So, at the end of the day, it just depends on your employee mix. The older and the higher paid your employees are, the larger the contributions. However, if your employee mix is younger and lower paid, then you can minimize any contribution to them.

You can analyze these plans in many different ways. The plans can be complex, so I will try to simplify your decision.

For most clients it boils down to the following:

1) How high is your tax bracket and how sensitive are you to taxes? If you are in a 40% tax bracket these plans make a lot more sense compared to a 20% tax bracket. Also, I have clients who will do almost anything for a tax deferral. You just have to determine where your comfort level is.

2) How much is your annual contribution and how much of the contribution is being allocated to you? If you want to do $100k plus annually and you can get 85-90% allocated to you (compared to your employees) then it may make more sense.

3) How comfortable are you to committing to a plan for a few years? These plans are permanent in nature, but you can terminate after a few years for reasonable cause. Terminating after a few years is usually not much of a problem, but you need to realize that these plans will require an annual contribution.

Most TPAs will use 5% in today’s market. This rate is a safe harbor rate and tends to work out better when cross testing a plan with employees.

You can, of course, use other rates like the 30-year treasury bond or actual return. Actual rate of return can eliminate many of the over-funding or under-funding issues that create challenges. But we tend to use actual return for larger plans with higher plan assets and many employees.

At the end of the day, the 5% rate offers testing benefits and does not require the actuary to recalculate the rate each year. But the 5% rate also offers one big advantage. It will be higher that the 30 year treasury rate, so it will allow for larger contributions.

The #1 reason these plans exist is for the tax deferral, so small plans can allow larger contributions for the business owner. Also, another big issue is that the higher 5% rate will create a wider funding range. This will help these same employers fund at a higher level if they choose.

So bottom line, the 5% rate will allow better funding and simplicity and is used for smaller plans (under 20 employees). But if you have a larger plan, you can consider the other options that can limit plan over-funding and create consistent funding levels.

Your contributions are determined by our actuary. It depends on your age and W2 income (or business profit if a sole proprietor). For years subsequent to plan set up, you will typically be given a range for you to contribute. You would decide the amount to pay and let us know.

If you choose to pay on the low end it could result in a slightly higher range in following years. Of course, if you paid on the higher end it could result in a slightly lower range in following years. But you will have a lot of control because you have control over your W2. We reach out to our clients in the fall to see how their year is going and what they anticipate their W2 to be. That way we can do plenty of planning before the year is up.

If you have employees, we will examine their payroll and determine a contribution to be made on their behalf.

We can normally turn an illustration in 1-2 business days. All we need is the following information:

1) Age or birth date
2) Desired retirement contribution
3) Number of full time employees

The above items will get us going. But if you have an employee census that details employee compensation (salary or hourly rate), birth date and hire date that would be great. We certainly can discuss this information after we do the initial illustration.

Yes, you can. One person owner-only plans are very common and allowable by the IRS. You do need to have income that is subject to employment taxes. This would be profits on a Schedule C for a sole proprietor or a W2 wage for a person with a C-Corp or S-Corp.

In addition, there is no age restriction or limitation. You can be 20 years old or 80 years old! However, the older you are the more you will be able to contribute.

Yes, in theory. Social security promises you a monthly financial amount at your eligible age. For a defined benefit plan, the company is making annual contributions so that it can provide a monthly financial payment to an employee upon retirement.

However, at the end of the day, defined benefit plans for small businesses don’t usually turn out to work the same way. At some point the company closes, gets acquired or the plan is otherwise terminated. At this point, accumulated benefits are typically rolled over into an IRA.

So even though the plans are structured to work similarly, in practice funds are usually not distributed in the same manner.

No. The reason is that rental properties generate passive income. This income is not subject to employment taxes (social security and medicare). So in the eyes of the IRS you are not truly self employed. You must be self-employed (or have a W2 from your business) in order to qualify for defined benefit plan.

However, we have seen certain structures where rental properties have been structured with a management company. This management company can possibly pay you a wage to work for the business. If you have questions about how to structure a plan with rentals, make sure that you discuss it with us and your accountant.

A cash balance pension plan is a specific type of defined benefit plan structure. The plan is solely funded by the employer and the plan document defines the participant contribution formula. With a “traditional” defined benefit plan, the participant’s retirement benefit is expressed as a monthly annuity that is payable upon retirement. This can be confusing because the current value of the employee’s account or accrued benefit isn’t apparent.

The IRS technically calls a cash balance plan a defined benefit plan because there is a benefit formula clearly defined in the plan. But it is generally considered a “hybrid” between a defined benefit plan and a defined contribution plan. This is because each employee’s benefit is essentially expressed as an account balance (somewhat like a 401(k) plan).

Each cash balance plan participant will receive both an annual interest credit and a pay credit. As such, a participant’s balance will increase each year by the amount of their pay credit and their interest credit.

Both traditional defined benefit plans and cash balance plans are required to offer payment of an employee’s benefit in the form of a series of payments for life. However, traditional defined benefit plans define an employee’s benefit as a series of monthly payments for life to begin at retirement, but cash balance plans define the benefit in terms of a stated account balance. These accounts are often referred to as “hypothetical accounts” because they do not reflect actual contributions to an account or actual gains and losses allocated to the account.

Cash balance plans are defined benefit plans. In contrast, 401(k) plans are a type of defined contribution plan. There are four major differences between typical cash balance plans and 401(k) plans:

1. Participation – Participation in typical cash balance plans generally does not depend on the workers contributing part of their compensation to the plan; however, participation in a 401(k) plan does depend, in whole or in part, on an employee choosing to make a contribution to the plan.
2. Investment Risks – The investments of cash balance plans are managed by the employer or an investment manager appointed by the employer. The employer bears the risks of the investments. Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts promised to participants. By contrast, 401(k) plans often permit participants to direct their own investments within certain categories. Under 401(k) plans, participants bear the risks and rewards of investment choices.
3. Life Annuities – Unlike 401(k) plans, cash balance plans are required to offer employees the ability to receive their benefits in the form of lifetime annuities.
4. Federal Guarantee – Since they are defined benefit plans, the benefits promised by cash balance plans are usually insured by a federal agency, the Pension Benefit Guaranty Corporation (PBGC). If a defined benefit plan is terminated with insufficient funds to pay all promised benefits, the PBGC has authority to assume trusteeship of the plan and to begin to pay pension benefits up to the limits set by law. Defined contribution plans, including 401(k) plans, are not insured by the PBGC.

The economics of cash balance plans and other defined benefit plans don’t work great for everyone. These plans are primarily driven by compensation and age. So the higher your W2 wage (or business profit) and the older you are, the more you can contribute and the more these plans make sense.

In addition, when you have employees it makes it more challenging. The ideal situation is older, high income owners combined with younger and low compensated employees. When employees have high income it can make it difficult because as a general rule you may have to give the employee 10% or so.

Our goal is to get 85% to 90% to the owners. But when you have younger owners and higher paid staff the economics can shift. When it gets to, for example, 70% owner and 30% staff, it just usually doesn’t make sense.

In addition, when the owner is young they often can’t get an allocation that is high enough when you consider the plan administration costs. These plans are more expensive because of the actuary cost to sign off. So when you assume that these plans will run $2k or so annually that can also hurt the overall economics.

So at the end of the day, it may not make sense and you are left with looking at a safe harbor 401k or a SEP.

I wish this was better news. But this type of plan won’t work well for your situation, and you will have to consider other options.

Your situation is actually not that unique. We deal with large physician groups where some of the physician partners just want to max out the 401k while others are looking to make contributions to a cash balance plan.

When there is a large medical practice with many partners/shareholders there is more complexity to these plans. That being said, they offer the physicians a great opportunity to make large tax deferred contributions.

Most groups will set up the plan with the following structure:

1) They will have a few groups set up with set funding amounts. For example, you would have a $50k group, a $100k group and a $150k group. Physicians who want to contribute will select a group as along as it is compliant.
2) Plans will seek to get covered by the PBGC, which will allow the physicians who want to stick with maxing the 401k the ability to do so. If you don’t do this, certain contributions will be limited.

There are a couple issues that need to be addressed:

(1) Structuring the plan to work for both the physicians who want to contribute and the ones that don’t.
(2) How will you make contributions to staff?
(3) Making sure the plan works with your tax structure.
(4) Is the plan required to be covered by PBCG based on 25 participants or do they want to apply?

Assuming some partners want to just contribute to the 401k and others want to include a cash balance plan, here is how it normally works. This can get a little complex, so I will try to be concise.

Combined plans are limited to a 6% profit sharing match on the 401k or 31% cap on total eligible compensation. Since the partners/shareholders who just want to stick with the 401k don’t want to be bothered by the cash balance plan, you let them contribute to the maximum $57,000 (or $63,500 if over 50).

You then calculate the total eligible compensation, multiply by 31% and then back out the 401k contributions. This will give you the remaining amount that can be contributed to the cash balance plan. Here is an example:

Total eligible compensation – $5,000,000
Multiplied by 31% – $1,550,000
Total Contributed to 401k – $1,000,000
Remaining to be allocated to cash balance – $550,000

With the remaining amount, you just have to divide it up and make sure you stay compliant.

Next, you need to make sure this works in light of your tax structure. Since the cash balance plan contributions are a tax deduction, the ultimate goal for the partners/shareholders is that they get the tax deduction and it is not allocated to other physicians. This can usually be done relatively easily with a C-Corp, but is a little more difficult with an S-Corp or partnership.

So I would want to answer the following questions:

(1) Determine which physicians want to contribute and which just want to stick with the 401k plan.
(2) For the physicians who want to contribute to the cash balance plan, what is an approximate contribution level?
(3) There will need to be a contribution made for some of the non-partner employees. However, it may not be relatively large because they are probably receiving a large contribution through the 401k profit sharing plan.
(4) What is your current tax structure?

I know this can be a little overwhelming. So let us know if we can schedule a call to discuss.

Neither of the terms Irrevocable or Revocable trust apply to your retirement plan, because those terms are for personal trusts. The 401K and Cash Balance plans are set up through your entity, and these plans do have some similar qualities to both the irrevocable or revocable trust functions. However, your plans can’t actually be labeled as either.

While most accountants and CPAs understand qualified plans, they may not be that familiar with defined benefit plans.

This being the case, here are a few things your accountant will need to be aware of:

1) These plans are qualified plans and have an IRS approval letter. You should share the plan documents with your accountant.

2) You have the ability to make the contribution up to the date you file your taxes (including extensions) and take a tax deduction on your prior year tax return.

3) Your plan contributions can be reported in a couple places on your tax return depending on your entity structure.

We have completed a comprehensive post that will show your accountant how to reflect your contributions on your tax return. See it here: https://emparion.com/deduct-cash-balance-plan-contributions-tax-return/ 4) If your accountant still has questions feel free to have him or her reach out to us. We are glad to help!

Once you complete our new plan checklist, it usually takes us around 3-5 business days to get a plan established. Although in many situations, we can have a plan set up in as little as 48 hours depending on time of year and plan complexity.

Here are the steps involved in setting up a Safe Harbor 401k plan:

1) There often is not an illustration to run. Because you have to tell your employees that you will match the first 4% they contribute. Based on your situation, they likely will not choose to contribute. This allows the owners to contribute $19,500 (or $26,000) and get the full tax deferral.

2) Based on your employee mix, the plans usually run around $990 to set up and $990 for annual administration. You would pay $990 upfront when the plan is drafted and then would owe $990 each year when we complete the administration. This is typically in Spring (April/May).

3) The good news is that based on recent tax laws changes, you can get a credit for the first three years of a plan that has eligible employees which are not highly compensated. In your situation, this would be a credit $750. So the plan is almost free for the first three years. This also covers the set-up cost. Your accountant can claim this when you file your tax return.

4) The one issue you need to deal with is deciding who the custodian will be and who will do the record-keeping for the assets. When employees contribute (or if they contribute), you will have to withhold the money from them and remit it to the plan. This requires some coordination with your payroll provider. We usually work with Voya because they can handle that process and also offer the investment options for the employees. But you can with work whomever you want. It usually takes a month or so to get that coordinated, so make sure you plan ahead.

5) If you want to get started you just have to complete our new plan set-up checklist. You will see it here: https://emparion.com/new-plan-set-up-checklist/

Our set up fees are all inclusive. There are no additional costs or fees for actuarial services, legal or tax.

Other than our set up fees and annual administration, you may need to consider the following costs:

1) Bonding (if applicable)
2) Plan amendment fees. The IRS may require your plan to be amended and restated on occasion. Our amendment charge is normally minimal, and our last required amendment fee was $400.

Rather than using a state interest crediting rate like 5%, you do have the option to use actual rate of return. But using actual rate of return does have some drawbacks.

If there is a negative or low year, we would use that as the projection rate for 401(a)(26) (minimum participation rule) and 401(a)(4) (rate group test), and the lower the rate, the more upfront cost needed to pass these tests. For example, for a 25-year-old employee, a 1% year will require a following year contribution 372.84% higher as compare to a 5% Cash Balance Plan. This can triple or quadruple staff cost to keep benefits equivalent to pass testing. The main point here is that similar money goes to staff through the combination of investment return and contributions.

If cumulatively negative return earned over time, the Plan must provide a cumulative floor return of 0% return over time, known as the Preservation of Capital Rule. Therefore, the Employer could have to contribute even more to the Plan to make up for this, whereas the employee does not share in the full extent of the downside risk.

If Plan earns 15% return, all participants receive this full credit. Thus, in this case the employees share this full windfall for doing nothing as opposed to the employer being able to use the surplus in the future. As compared to a 5% return Plan, the employer could use this surplus to reduce a future contribution similar to a forfeiture.

As a result, we would generally only use the market or actual rate of return for plans with large number of owners/partners and few employees. For plans with one main owner and a handful of employees it is typically not recommended and seldom used.

You may be eligible for a tax credit to offset your plan costs. Plans covered under this credit would be cash balance plans, defined benefit plans, and safe harbor 401(k)s. The credit is $250 for each qualifying employee. The minimum credit is $500 and the maximum credit is $5,000. The credit covers the set-up costs and annual administration. You can claim it for the first three years of the plan.

In addition, you can select to claim the credit in the tax year before the plan becomes effective if you choose. It is claimed on Form 8881 that is filed with your business tax return. You can find the form here: https://www.irs.gov/forms-pubs/about-form-8881 

The credit applies if the following conditions are met:

1) You have 100 or less employees who have over $5,000 in compensation for the previous year;

2) You had at least one eligible participant who was not deemed a highly compensated employee; and

3) In the three years prior to the first year you claim the credit, your employees weren’t essentially the same employees who received retirement contributions under another plan you sponsored.

The bad news is that most solo plans don’t qualify because they don’t have any qualifying employees. The business owner is considered a highly compensated employee and is excluded.

Profit sharing portions of a 401K plan are required to allocate contributions to each participant in a nondiscriminatory method. New comparability is one type of allocation method that can be used.

New comparability is favored by some business owners because, in the right scenarios, it can provide a way to maximize the owner’s annual contribution to the annual IRS limit while still passing compliance testing with lower contributions to non-highly compensated participants.

For new comparability to function in favor of the owner, the average age of the owner(s) must be greater than the average age of the other employees. The greater the difference between the ages, the greater the allocation is in favor of the owner.

New comparability is not based on set amounts for each participant, it first separates the participants into groups based on objective criteria, and from there each group is tested separately using the required compliance testing methods. Because these groups typically separate older and more highly compensated participants from younger and lower paid participants, each group passes testing with more favorable contribution amounts.

There are multiple tests that a 401K plan with profit sharing will need to pass in order to maintain the qualified status. I think when you are talking about 5% to all non-highly compensated employees you may be thinking of the gateway test requirement. This requirement states that defined contribution plans must be designed to demonstrate that allocations are nondiscriminatory on a benefits basis, and each non-highly compensated employee that is eligible for a plan must receive at least 5% of their compensation in allocations. This normally is passed between deferrals, safe harbor matches and profit sharing. However, only 5% of allocations to each employee is not always enough to pass other compliance testing, especially when owners are working to maximize.

We will make all plan documents available in your SmartVault account. This is where we are securely storing copies of your plan documents and annual reports for you to access at your convenience.

When a plan is set up, you will receive the following documents:

• Adoption Agreement
• Plan Document
• Consent of Action
• Summary Plan Description
• Participant Highlights
• Beneficiary Designation (You will need to print, fill this item out, and return a copy to us for our records)
• IRS Advisory/Opinion Letter
• Plan EIN

A defined benefit plan or cash balance plan must be set up by the time you file your business return (including extension) for the related tax year. For example, let’s assume you have a calendar year-end, you can adopt the a 2020 plan as late as September 15, 2021.

But realize that the investment account must be set up and funded by this date as well. So, you will need to coordinate with your administrator and custodian well in advance of the deadline.

One big advantage of cash balance plans is that they can be funded up until the date the tax return is filed (including extensions). The latest date being September 15th. This would allow you to take a tax deduction on the prior year tax return.

In year two of your plan, you will usually have more flexible funding options. You will be given a minimum contribution, maximum contribution and a targeted amount. If you decided to front load your plan, then you might see a reduction of 20% to 40% in year two.

However, if you established a base contribution that is in line with your compensation, then usually in year two your minimum contribution might be 10% on the low end and the maximum contribution might be 50% above your year one contribution. So, you will have some funding flexibility in year two. This is especially true to the upside.

But if you want us to take a look at your situation, just ask us. But of course, this depends in part on the return on your assets and your compensation or business profit for a sole proprietor.

Once your plan is open, you can begin to contribute. However, your annual contribution amount will not be finalized until the end of the year. Final calculations will be done based on your W2 or full year business profit.

So, if you have a draft of a funding amount for the year based on your projected numbers, you don’t want to make a full contribution. We recommend that you are conservative and contribute a smaller amount (possibly 75%). That way there is some cushion if the annual profit or W2 is lower than expected. The remaining 25% contribution can then be made up to the date the tax return is filed, including extensions.

Sole proprietors don’t pay themselves a wage. They are taxed on the net profits of the business. When it comes to determining the contribution, our actuaries need to determine a “deemed wage”.

Calculating this wage is complex, but essentially the wage, half of the employment taxes and the defined benefit plan contribution will equal zero. Playing into the calculation is age, etc. As a rule of thumb, the “deemed wage” is usually around 50-75% of the business profit.

There will of course usually be some variation as it relates to a contribution range. But sole proprietors require more complex contribution calculations, especially when it comes to front loading plans. If a client is an S-Corp we can usually front load the plans real easily.

This is because we can take a W2 wage and take the contribution up to the 415 limit (essentially the annual contribution cap based on age). We can also often add a prior service adjustment and increase it by 50%. But being a sole proprietor makes it much more challenging.

A contribution is based on a calculation whereby we have to determine the “deemed” wage (we can’t take the entire profit) and back into the maximum contribution based on age. It is much more limiting. We can never go higher than the sole proprietor profit, less half of self-employment tax.

But to go this high we need to have prior service. The sole proprietor contributions are much more restrictive. When there is no prior service, they are stuck at a “base” calculation.

This is a common concern. Let’s say this year is a great year for you and you want to put large amounts into a cash balance plan.

But you have concerns about next year. Maybe that large contract might not renew? Maybe you want to work fewer hours? In any case, you are concerned about future plan contribution amounts. We see it all the time.

We understand that business income can fluctuate from year to year. That’s why we have a few strategies that can solve this problem.

#1 – Adjust compensation

Assuming your business is structured as an S-Corporation, a big driver of the annual contribution amount is your W2 compensation. So if your income is way down, presumably your compensation might be down as well. Please realize that you still are required to pay yourself reasonable compensation. But lowering compensation is a big consideration.

#2 – Fund low end of range

When an actuary calculates required annual contributions, there are certain assumptions and estimates. These items will typically provide a funding range. For example, your funding range may be $60k to $100k. This will provide you with some discretion to fund larger amounts in good years and lower amounts in other.

#3 – Amend the plan

Lastly, you can always amend the plan to provide for lower contributions (subject to testing). However, you cannot amend the plan to lower benefit amount once employees have met eligibility for the year. This would typically be working 1,000 hours.

A cash balance plan doesn’t really have an annual contribution limit like a 401(k). This is because it is trying to reach a specific amount upon retirement (typically at 62 years old).

Contributions toward a cash balance plan can be as high as $300,000 as the participant nears retirement age, subject to their level of income. But here is an important point to note. In reality, even though your target contributions will change each year you will be given a range.

For example, your targeted contribution may be $150k, but you may have a low-end range of $75k and a high-end range of $400k. This gives you a little flexibility each year.

We have a post here that has plenty of detail: https://emparion.com/cash-balance-plan-lifetime-contribution-limits/

Probably not. If you have many, high income employees you may not be able to structure the plan to maximize funding for yourself. You can include certain groups in the plan, and this can help benefit certain employees. But you may want to consider a plan in light of your current employee benefit structure and tax bracket to determine if a plan is right for you.

The range you are given represents the minimum and maximum funding levels. As a general rule, the targeted funding level would be somewhere in the middle. This allows you some discretion to contribute a larger amount in a good financial year and a lower amount in a lean year.

But please be careful. If you consistently fund at the low end of the range, then future minimums will start to increase and push funding amounts higher. Likewise, if you consistently fund at the high end of the range, you will find that maximum contributions will start to decrease, and future funding amounts can be limited. Please ask us if you want further clarification on this issue.  

This is a fairly common problem, but it can usually be corrected. You must remove the excess contribution and any earnings on the excess contribution ASAP.

The first step is to quantify the excess contribution as well as any earnings that have accrued on the excess contribution. Second, you must contact your custodian immediately and inform them of the error. They will typically provide you a form to remove the excess contributions and any earnings.

The custodian will report the distribution on Form 1099-R along with the earnings that you made. The distribution is not taxable, but the earnings are. Of course, you should NOT take a tax deduction for the excess contribution.

Your contributions are not fixed upfront. They will go up or down each year. If your income is higher next year they will go up, and of course if your income goes down then your contributions will go down.

But here is an important point to note. In reality, even though your target contributions will change each year, you will be given a range. For example, your targeted contribution may be $75k, but you may have a low-end range of $50k and a high-end range of $100k. This gives you a little flexibility each year.

Plans can be structured so that they provide for prior services provided. Basically, you can look back to prior years and use compensation from those years to make a larger credit in the current year.

In the year of set-up, you would then make a one-time opening credit for this past service. It’s almost like a “catch-up” contribution. This contribution is tax deductible in the current year and you do not amend prior tax returns.

This strategy allows a business owner to make maximum contributions that will exceed the targeted contribution in that year. You can then get a tax deduction in a year when income will be high.

But be careful, prior service is applicable to any eligible employees who worked for the company. You may have to contribute for employees who may no longer work for the company.

We get asked this question a lot. There’s a lot of misinformation on the topic. The answer depends on whether you have any employees (outside of owners and spouses).

First of all, there are two components to a 401k contribution: (1) the employee deferral; and (2) the profit sharing contribution.

The elective deferral is the contribution that is made by employees to the plan. It is up to $19,500 or $26,000 if age 50 or older.

The common answer for the employee deferral is that it has to be done before December 31st or at least on the final payroll for the year (no later than Jan 15th). This is because the Department of Labor states that a company cannot withhold employee retirement funds and not timely remit them.

For non-owner employees, these must be elected by the end of the year and deposited into the employee’s retirement account within 7 business days (safe harbor rule) and no later than 15 days. There has been no debate on this issue.

But there has been debate for the owner/employees. These employee deferrals must be elected by the end of the year but can be contributed by the tax filing deadline (including extensions). This is because a solo 401k is a non-ERISA plan and fortunately not subject to the Department of Labor rules because it is just for owner-only businesses with no qualifying or eligible employees. For an S-Corp or C-Corp, the election is reflected on the W2 in box 12A, Code D.

There is no debate regarding the profit sharing contribution as it’s clear that it’s due before the tax return is filed (including extensions).

A good reference that supports this position is the IRS publication on retirement plans. There is a chart on page 3 found here: 2019 Publication 560 (irs.gov)

These plans are largely determined by age and W2 income, so the older and the higher the W2 the more you can contribute. In the first year you have a little bit more flexibility and can front load the plan. But this can have the following impact:

1. If you want to fund at a similar level in the next few years then you may want to consider increasing your W2 this year. If you don’t you may find that next year’s contributions will be a little lower.
2. If you had a good year this year and are looking for a nice tax deduction and you think next year’s income will be lower, then you may be fine leaving this year as is.
3. If you want higher contributions for next year, then you will most likely have to get next year’s W2 up.
4. If you just want to get this year done and not worry about next year that’s fine.

The moral of the story is that if you are looking for similar contributions in future years, you may want to consider getting your W2 compensation higher for the current year. But if you are OK with the items noted above then that’s fine. Make sure you also discuss the issue with your CPA.

For cash balance plans, the “5-year commitment,” is typically a TPA recommendation to provide a blanket expectation of the lifespan of a cash balance plan. Although these plans are permanent in the eyes of the IRS, with reasonable cause you can terminate the plan at any time.

A majority of our clients keep these plans for an average of 5 – 7 years, but we do have clients who terminate before then or keep them open for longer periods. Due to the many factors involved with calculating cash balance contributions, (mortality tables, IRS limitations, compensation, investment performance, etc.) it’s hard to project exact amounts for the next 5 years of contributions to the cash balance plan.

If all things were to remain the same, we could expect that the funding target would increase around 5% a year. Each year we will calculate a funding range based on age, compensation, and investment performance.

Here is a brief overview of each factor and how they affect the range each year starting in year two:

• Age – each year participants get closer to retirement so that always increases the amount that can be put in

• Compensation – creates a base for how much can be put into the plan. If compensation decreases it would shift the funding range to a lower minimum and maximum, and if compensation increases that will increase minimum and maximum

• Investments – if investments under-perform, contribution will have to offset some of the loss (however it isn’t dollar for dollar, it would increase the maximum funding amount) and if the investments perform really well, it will limit the maximum funding amount which would reduce the deduction for the year.

This is why we typically recommend that cash balance plan funds are invested in a conservative and less risky way. This helps keep level funding ranges. We will also include a target funding amount. This is the amount which will keep contributions on target with where the funding should be for that year.

Each year that the funding amount is in line with the target, it will maintain a flexible funding range for following years. This allows some discretion to contribute a larger amount in a good financial year and a lower amount in a lean year. After a few years of funding at the target will expand the funding range, until the minimum is $0 and the maximum will be the IRS limit for the year.

Although, if funding is consistently at the low end of the range, then future minimums will start to increase and push funding amounts higher. Likewise, if plans are consistently funded at the high end of the range, eventually the maximum contributions will start to decrease, and future funding amounts can be limited.

No. We are not financial planners or advisors. We are third party administrators, and our job is to determine funding and monitor compliance.

You would presumably be the plan sponsor and trustee, and your job is to manage the plan investments. You may hire a financial advisor to do this for you or you might select a discount broker like Charles Schwab, Fidelity or Vanguard. Since our plans are IRS approved qualified plans, you can use any financial advisor you like.

We aren’t able to fill out your Charles Schwab application for you. However, we have created a blog post with detailed instructions on how to complete the application.

To access these instructions, click the following link: https://emparion.com/setting-up-cash-balance-plan-at-charles-schwab/

We aren’t able to fill out your Fidelity application for you. However, we have created a blog post that thoroughly explains how to fill out the application and lists everything you will need to set up your investment account.

To view these instructions, use the following link: https://emparion.com/setting-up-a-cash-balance-plan-at-fidelity/

We aren’t able to fill out your Vanguard application for you. However, we have created a blog post with detailed instructions on how to fill out the application correctly.

To access these instructions, click the following link: https://emparion.com/how-to-set-up-your-defined-benefit-plan-account-with-vanguard/

Our plans work with virtually all custodians. When you set up a plan with us, you receive a trust document. This is a tax-exempt retirement trust.

You must ensure that whatever custodian or investment advisor you use, they set the plan up using the retirement trust document. If the investment account is not set up correctly, you could receive a 1099 at the end of the year for interest, dividends and capital gains in the account. This would be incorrect because these plans are only taxable when you take the money out of the plan.

In addition, if the contribution is not made to a tax-exempt retirement trust, the IRS could deem the contribution invalid and assess tax on the entire contribution. So, you want to make sure you set it up correctly upfront.

At Emparion, we are plan administrators and not financial advisors. During our onboarding process, we will discuss your investment custodian application(s) and account set-up process. We supply you with tips, articles, phone numbers, and any information we have to help you set up your investment account. But at the end of the day, it is your responsibility to get the investment account set up correctly.

When you complete your plan set up checklist, you have the option to have us set up the custodial investment account for an additional $400 fee. Also, it might make sense for you to have an investment advisor who can set up the account for you.

Many banks (both large and small) don’t have a lot of experience opening a bank account for a retirement plan.  Here are some tips to make this process easier.

1. Bring a copy of the EIN provided when plan documents were set up for your retirement plan. The plan EIN will be used to open your bank account. Do NOT use your social security # or the EIN for your company.
2. In most instances the banker will not need to see the actual plan document.  If you want to be safe, print off the Adoption Agreement and bring it into the bank.  But please realize that it is a lengthy document (normally 30 pages or so).  Any documents they request should have been provided when the plan set up was completed.
3. Tell the banker that you wish to open a “Trust” bank account and not a business or personal bank account.  Often the banker will assume that you are seeking to open a solo 401k with the bank as the trustee.  This is of course not the case as you will be trustee for the plan.
4. You may need to explain that a self-directed 401k falls under the Internal Revenue Code and falls under the retirement trust umbrella and that the business owner can serve as the trustee of the trust.
5. The business owner as trustee directs all investments and decides on the bank or credit union of where to hold the trust liquid funds; therefore, the bank will not serve as the trustee of any of the alternative investments
   1. (e.g., real estate, precious metals, tax liens, notes, private shares, etc.) and will not administer the plan.
6. If there is still confusion, you can recite the following.

Trusts and trustees. 401(k) plans are funded through a trust established to hold and invest the plan’s assets. At least one trustee is appointed to have responsibility for the activities of the trust and its assets. This is a serious responsibility with considerable potential for liability. Trustees might include the business owner, an employee, or a financial or trust institution.

Other Common Questions You May Encounter:

Question. How is account titled?

Answer: The bank account is titled in the name of the solo 401k trust.

Question: Who is the trustee?

Answer: You, the business owner, is the trustee.

Question: Who has signing authority?

Answer: The solo 401k trustee has signing authority.

Question: What banking features are allowed for the solo 401k trust bank account?

Answer: Check writing, debit cards, ACH, wires and cashier checks are permitted; however, credit cards and personal lines of credit are not.

We are third party administrators and we are not custodians or investment advisors. Most clients will have a relationship with a financial advisor and just use our paperwork to open an account with them. But you also could set up your own online brokerage account and fund it that way.

You can invest in basically anything you want. Most people will do stock, bonds, mutual funds, CDs etc. But you can also do real estate, etc. The big issue is that if you do real estate, you need to make sure that you can give our actuary a value at the end of the year. We need to have a fair market value of all assets in the plan as of the end of the year.

As far as investments are concerned, you have the flexibility to invest your funds as you see fit. You can invest in basically anything you want. Most people will do stocks, bonds, mutual funds, CDs etc. But you can also do real estate, etc. The big issue is that if you do real estate, you need to make sure that you can give our actuary a value at the end of the year. We need to have a fair market value of all assets in the plan as of the end of the year in order to run our calculations.

Yes, you can have multiple investment accounts. As long as each account is set up under the trust with the EIN that we provide, then it would be fine. Our actuary will need the balance in each investment account as of the end of the year in order to determine contributions and compliance.

The reality is that you are the plan sponsor and trustee. Even though most people will invest at least a portion of the money into the stock market, you are not required to do so. You have the ability to invest in almost whatever you want (subject to certain restrictions).

But remember that these plans are targeting to have a certain amount of money at a point in the future when employees (such as you) retire. So large investment returns mean that the company does not have to contribute as much to reach that targeted funding amount. Conversely, if the stock market goes down substantially this may require the company to make larger contributions to make up for this decrease.

The goal is to have slow and steady returns to minimize funding volatility. So if you plan on making more speculative investments, you may want to consider doing this in a defined contribution plan like a 401k.

It is also important to note that you are given a range to contribute each year and this will fluctuate based on a variety of criteria one of which being investment returns.

As you are aware, we at Emparion are not financial advisors and we cannot give financial advice. But it is critical that you understand how the interest crediting rate works.

First of all, your plan comes with a stated fixed interest rate of 5%. What this means is that the plan assets have an assumed return of 5% and our actuary will model contribution levels using this rate. As such, the goal of the plan is to generally mirror this rate. 

We know that most of our clients seek consistent annual contributions to lower taxable income. That’s why they want to make sure that they invest plan assets conservatively.

Large investment gains and losses lead to funding volatility. This can lead to large swings in annual required contributions. If your gains exceed the 5% rate, your future contributions will trend lower. On the other hand, if your investment gains are less than 5% it will push future contributions higher.

As such, we would recommend that you use a conservative investment approach. An investment allocated 100% to stocks is not recommended. If you desire more stock market exposure, please consider increasing stock allocation in IRAs, 401ks and other defined contribution structures.

You are able to manage your own plan assets. However, if you are uncomfortable managing these investments, you should consider using a financial advisor that is familiar with these plans.

In the meantime, if you want further information, please see a detailed article we wrote on the subject here:

In addition, here is YouTube video that addresses the topic:

Defined benefit plan (or cash balance plan) contributions are made to a “pooled” account. What this means is that the contributions are made lump sum to one account and individual accounts are not opened for each participant in the plan. Unlike a 401k or even an IRA, there are no participant sub-accounts whereby each employee can pull up an online account balance at any point in time. This pooled account is required because the plan itself looks at combined funding amounts for all employees.

However, just because the funds are not segregated into specific employee accounts does not mean that they are not tracked at the employee level. We at Emparion will track the individual account balances allocated to the employees and provide participant statements. This also includes vesting and forfeitures so all contributions can be properly allocated.

All cash balance plan participants must be 100% vested after 3 years of participation. As a result, most plans that we set up are on a 3 year vesting schedule. This is sometimes called “cliff vesting” because 100% of the account balance is vested at the 3 year mark.

What vesting means is that participants do not have “ownership” in any plan contributions until they hit the 3rd service year. If a participant quits or terminates before the third year of service, all contributions will be forfeited back to the plan and can be allocated to reduce future contributions.

Please realize that if a plan is terminated, all participant accounts will become 100% vested.

We provide all actuarial services for your plan, and it is included in our pricing. There is no need to hire an outside actuary.

When we set up a plan there is a fee to draft the plan document and provide any consultations and customizations. But cash balance plans also have required annual maintenance. This is mainly because our actuary has to “certify” your contribution each year.

The following has to be done annually, and is covered by our fee:

• Annual consultations regarding funding issues;
• Actuary sign-off and certification of final contribution amount;
• Plan testing to ensure compliance with DOL & ERISA;
• Preparing employer and employee benefit statements including actuarial valuation reports;
• Ensuring the plan is in compliance with the IRS non-discrimination requirements;
• Coordinating cross-testing with other plans along with non-discrimination testing; and
• Filing required IRS 5500 tax return.

Unfortunately, you have to do all the above on an annual basis. We send out our annual administration invoices in April for the prior year compliance.

Many people do not realize that when a 401K profit sharing plan is combined with a cash balance plan, the profit sharing contribution amount will decrease.

A standalone 401K plan allows for a profit-sharing contribution up to 25% of compensation. However, when a cash balance plan is combined with a 401K profit sharing plan, the profit sharing contributions are limited as follows:

1. An overall employer contribution of up to 31% of compensation. This would include a total of all the cash balance contribution, Safe Harbor Match/Non-elective contribution and the profit-sharing contribution.
2. The employer contributions within the 401K plan cannot exceed 6%. This would include the total of all Safe Harbor Match/Non-elective contribution and the profit-sharing contribution.

Typically for an owner looking to maximize their contributions for a plan year, we calculate funding amounts that will follow the 6% limitation within the 401K plan. This allows for a greater cash balance plan contribution.

A combo plan is still subject to nondiscrimination and compliance testing, not just the combined plan limitations. This will also influence the contributions and allocations for each participant. Our actuary must calculate and certify the amounts each year to ensure the combination meets qualified plan requirements.

No, you cannot. You can’t contribute to a SIMPLE IRA for any year in which an employee either: (1) receives an allocation of contributions in a defined contribution plan, such as a 401(k), profit-sharing, money purchase; or (2) accrues a benefit in a defined benefit plan for any plan year beginning or ending in that calendar year.

Yes, you can. But the IRS has some restrictions and limitations. You can find out more here: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

You certainly can. But there are a couple considerations. You can make an employee deferral of $19,500 for 2020 ($26,000 if 50+ years old). But your profit-sharing contribution is limited. Rather than the normal 25%, you can only do 6%. But approx 90% of our clients have both plans.

You can combine a SEP with a cash balance plan but there are some considerations: (1) it has to be a non-model SEP and NOT subject to IRS form 5305; and (2) contributions under the SEP are limited to 6% for a non-PBGC covered plan.

In practice, we have found that most SEPs are model plans and are not allowed to be combined with a defined benefit plan. So if you are considering setting up a defined benefit plan and you currently have a SEP, make sure not to fund the SEP yet.

If you have already funded a SEP and want to set up a defined benefit plan, make sure you talk with us. You may be able to have those funds reclassified and disbursed back to you without incurring taxable income or penalties.

The following companies below have non-model SEPs:

• Charles Schwab
• Merrill Lynch
• Morgan Stanley
• American Funds

Before you proceed, make sure that you confirm with the above companies that they are non-model SEPs and NOT subject to Form 5305.

As a general rule, 401k profit sharing plans will limit the profit sharing contribution to 25%. The employee deferral is only limited by earned compensation.

When a 401k profit sharing plan is combined with a cash balance plan or other defined benefit plan, the rules state that the company is restricted to making a 6% maximum contributions under the profit sharing plan. There is no such restriction on the employee deferral because it is contributed by the employee and not the employer. So the final retirement contribution would be as follows:

1) Employee deferral (elective)

2) Profit sharing match up to 6% (elective)

3) Cash balance plan contribution (mandatory)

When life insurance is included in a cash balance plan or defined benefit plan, it must be allocated to all eligible employees. The inclusion of life insurance will usually result in a tax liability to the employee based on the “economic benefit” of the insurance protection. Employees have to pay income tax each year on the part of the premiums attributed to the value of insurance.

This is a taxable event to the employee because the insurance premiums are paid with pretax dollars. But the IRS considers the pure cost of the life insurance provided as an economic benefit that is immediate taxable income to the insured. The cost of the insurance that is taxable is calculated using IRS tables that estimate the insurance cost at each age of the insured.

This economic benefit is calculated by the insurance company. The employee then will receive a 1099-R at the end of the year and must pay taxes on this amount.

These plans can work well for many business owners. However, the plans are often not explained very well, which can lead to disgruntled business owners.

As a result, we help business owners terminate 412e3 plans and insurance only plans all the time. Our fee is typically $1,950 for all the termination paperwork and IRS required forms. Here are a couple things that need to be done along with a couple comments:

1) We can immediately terminate the plan and eliminate future contributions. However, depending on eligibility requirements, you may be required to fund the plan for the current year and even the prior year (if contributions have not already been made).
2) If you are not able or willing to fund the plan, the IRS may impose a penalty. This penalty will be approximately 10% of the unfunded contribution.
3) When you cancel the insurance, there may be certain fees or costs that are imposed by the insurance company. Be sure to check with the insurance agent.
4) We can assist with rolling over the cash surrender value of the insurance into an IRA or other qualified plan.

Here is an article that addresses the termination of 412e3 plans in greater detail – https://emparion.com/terminating-closing-412e3-plan/

Unfortunately, we do not currently set up these plans. It is usually better to go to an insurance company who can directly administer them. We’ve also found that after the plans are up and running for a few years, many clients are not happy with them because of the insurance products and inflexibility.

However, cash balance plans can be funded with 50% insurance. We do set these plans up. If you are interested in a plan like this please reach out and we can assist.

Yes, they can. But if you want to terminate your plan, just make sure that it’s a business necessity. A business necessity would usually involve lower business profits, change in ownership, or an issue that restricts funding the plan. The IRS has even accepted the fact that a company adopted a different retirement plan as a valid reason to terminate.

When you terminate a plan you have the option to file form 5310. When this form is filed, you are basically asking the IRS to make a determination on the plan’s qualification status at the time of the plan’s termination. It does not say that the funding was accurate and it is not asking the IRS to sign off that all funding and compliance during the period the plan is open was approved.

In practice, it is not filed very often. This is for the following reasons:

1. They are expensive to file (often costing around $6k).
2. The IRS usually takes a year or so to process.
3. Many plans were drafted on pre-approved documents.
4. The IRS is not “certifying” that the plan operated and funded correctly.

In most situations, they are filed for companies with many employees (like 50+) or if there were many partners in a professional practice (like 20 physicians in a large practice). The reason is that there could be a problem with an employee and the IRS determination letter could be helpful. In addition, they might make more sense if you had a custom plan document or possibly a history of compliance issues with the plan.

Most solo practitioners would not pay to have it filed. If you want to discuss in more detail, just reach out to us.

Yes, you can. If a plan is terminated, you may roll the funds into a 401k plan or other qualified plan. Most people roll the amounts over into an IRA for simplicity. If the funds are rolled into a 401k plan, there may be an ongoing form 5500 filing requirement.

Assuming the plan is terminated, you can roll the funds over into an IRA. You can take money out of the plan in a full lump sum payment or, alternatively, take that lump sum and roll it into an IRA.

Because the funds in the cash balance plan have not been taxed, you may elect to deposit the funds into a traditional IRA. A traditional IRA is tax-deferred until retirement.

Form 5558 is filed to apply for a one-time extension of time to file Form 5500, which covers retirement plans. A separate Form 5558 must be filed for each plan for which an extension is requested. For example, if an employer maintains a defined benefit plan and a 401(k) plan, a separate Form 5558 must be filed for each plan.

Form 5558 must be filed by July 31st for the prior calendar year. It allows an extension of 2 1/2 months or up to October 15th to file the final 5500.

Unfortunately, the IRS does not confirm acceptance of Form 5558 filings. But we rarely see issues with extensions not being accepted. In addition, we file our extensions under a certified letter that shows evidence of the filing. So we rarely see problems with extension filings.

Clients need to make sure they communicate to us the need for an extension filing, even though we will generally file one if we don’t have enough information to file form 5500. As long as you have communicated with us the desire to file an extension, we take responsibility for getting the extension filed and dealing with the IRS in case they claim it was not received.

From time to time, we see the IRS issuing letters confirming that an extension was filed and requesting that the final 5500 be filed by the October 15th deadline.

If you receive such a letter, feel free to forward it to us. However, the IRS is just requesting that the form be filed by the deadline. We are responsible for your filing deadline and meeting this requirement as long as you submit to us all applicable information for the filing.

So, generally speaking, you can just hold onto this letter for your records, and we will confirm with you when the actual form 5500 is completed. It will also be uploaded into your SmartVault account.

If you are buying a that company already has a defined benefit plan in place, you have a couple options.

1) You can keep the plan in place and have the current plan administrator perform all the administrative functions.
2) You can keep the plan in place and have Emparion take over the plan administration.
3) You can terminate the plan and then distribute the funds out to an IRA or other qualified plan. But before you do this make sure you understand the implications. You may be required to make a contribution and also all participants become fully vested. So before you do this make sure you consult with us or your current plan administrator.

The following is a list of items we will need in order to take over your plan:

• Plan Adoption Agreement with any amendments
• Summary Plan Description, if available
• IRS Favorable Determination Letter, if available
• Form 5500 and Attachments for the last 2 Years
• Actuarial Valuations for the last 2 Years
• Year-end Statement of Plan Assets for the last 2 Years
• Compensation History for ALL employees for the last 2 years
• Current Employee Census

We may need a few more items, but this is a good start.

Where cash balance plan and other defined benefit plan contributions are reflected on your tax return depends on your entity structure. Our clients set them up under the following entity structures:

1) Sole proprietor or single member LLC (Schedule C to 1040 return)

2) Partnership (Form 1065)

3) S-Corp (Form 1120-S)

4) C-Corp (Form 1120)

We have dedicated an entire post to this topic here: https://emparion.com/deduct-cash-balance-plan-contributions-tax-return/

Yes, we do. We charge an additional $500 annual administration fee for all the compliance services associated with self-directed defined benefit plans and cash balance plans.

While we don’t endorse any banks or financial institutions, many of our clients use Titan Bank or Solera Bank. You can find out more about them below:

Titan Bank | Small Business | Solo 401k Bank Accounts

Self-Directed Checking (solerabank.com)

Every defined benefit plan or cash balance plan requires annual valuations of plan assets. This is easy for stocks, bonds and mutual funds. But there are no fixed and determinable market prices for real estate and other non-qualifying assets.

Since these plans require annual actuarial calculations, the administrator will need to have the fair market value of all plan assets. This is because the actuary needs to make sure the plan has enough assets pay future benefits. Determining the annual valuation of plan assets at year-end is a critical step in the compliance process. You should consider employing an independent, outside appraiser if determining valuations is challenging.

As a general rule, ERISA doesn’t cover solo plans, so you can file Form 5500-EZ. But if the plan has non-qualifying assets, you must file Form 5500. This is because there is no ‘solo participant plan’ election on the form, so the plan will qualify as a single-employer plan, thereby falling under the bonding rules.

The reason bonding is required is because the Department of Labor requires an annual audit for plans with fewer than 100 employees. However, the annual audit requirement is waived under the following circumstances:

• Less than 5% of the plan’s net assets are from “non-qualifying assets” or
• The retirement plan has a fidelity bond that covers 100% of the value of all plan non-qualifying assets.

Because most plans have qualifying assets like stocks, bonds, and mutual funds, there is no audit or bonding requirement. But if there are non-qualifying assets and no audit is performed, then the plan must have bonding. But bonding is not as bad as you might think. It usually costs a few hundred dollars a year and there are large discounts for buying multiple years up front.

There certainly are. The compliance issues generally revolve around bonding requirements, 5500 filings, and valuation concerns.

Even though most companies will invest plan assets in stocks, bonds and mutual funds (what I would call qualifying assets), you do have the ability to invest in other non-qualified investments. This would include real estate, precious metals and gold, mortgages or hard money loans, bitcoin/other cryptocurrencies and even partnership units and private placements. So you have plenty of options.

However, these types of investments present a lot of challenges to the plan. So I would do these types of investments first in an IRA with the next option being a 401k.

The good news is that you can self-direct a defined benefit plan or a cash balance plan.  You can invest your funds in real estate or other non-qualifying assets.

But there are some complexities and pitfalls that must be avoided. In addition, you must hire an administrator (TPA) that understands how these plans work.

You can use a defined benefit plan to invest in what’s called non-qualified assets, such as real estate. But as a general rule, we recommend against it for several reasons.

First of all, there is added plan complexity. This involves valuations at the end of the year, bonding requirements, and a more complex form 5500 filing. As a result of the increased compliance and complexity, we charge an additional $500 annual fee when a plan has non-qualified assets.

Second, most people have IRAs or 401(k)s. These plans also allow for self-directed assets. However, because they’re defined contribution plans and not defined benefit plans, they do not have valuation issues or funding problems like a defined benefit plan. So they are much better structures for investing in real estate.

Third, defined benefit plans are great when the goal is to make significant tax-deductible contributions. But real estate and other investments can lead to riskier and more volatile returns. This can make your plan funding very inconsistent. In fact, having very high investment returns might restrict or severely limit you from contributing to the defined benefit plan in the future. However, if you had those higher returns in an IRA or 401(k), you would not have the same restrictions.

I have seen clients who want to do real estate in a retirement plan, but when I ask them about their portfolio mix they often have qualified assets (stocks, bonds, mutual funds, etc.) in an IRA or 401(k). So generally, I would advise you to use those plans first for real estate. Once that is addressed, you can make subsequent non-qualified investments in a defined benefit plan. This assumes you want virtually all your assets in real estate and other non-qualified investments.

But again, you certainly can have their real estate in a defined benefit plan if it meets your goals and you understand its risks.

Here is an article I wrote on the topic and also a YouTube video. Let me know if you have any questions or want to discuss it in more detail.

Yes, you can. But there are a few considerations before you proceed. You can borrow the lesser of 50% of the vested employee account balance or $50,000. It is the lower of these two amounts. Again, the maximum loan balance is calculated based on the employee’s hypothetical account balance and NOT the entire balance in the cash balance plan investment account.

Cash balance plans are established with three-year vesting. So you cannot borrow from the plan in the first three years unless we provide a plan amendment to allow immediate employee vesting. 

Since we do not manage your plan investments, make sure you check with your investment custodian first to confirm that they can process and fund the loan request. In addition, they will need to be able to receive the loan payments.

There are also administrative fees as follows:

Plan Amendment – $250

Loan Document – $150

Amortization Schedule – $150

Total Setup Cost = $550

In addition to the above costs, loan balances must be reported annually on IRS Form 5500, and the end-of-year loan balance is included in the actuarial valuation. The additional reporting will add $150 to the annual administration fee beginning next year, and for each year the loan is outstanding.

Loan payments must include both principal and interest and must be repaid monthly or quarterly with a term of five years. As the plan’s trustee, you will be responsible to track and monitor compliance and report to us any taxable events.

Because of the above costs and the compliance issues, we advise clients to make sure this is something they really want to do. In most situations, there are easier ways to raise necessary funds. Once we process the loan paperwork, we cannot offer a refund on our administrative fees.

Please let us know if you want to proceed and we can send you over an invoice for the above fees and get started on the process.

Here is the process if you want to move forward with a loan. Once payment is received, we will draft the loan documents based on your answers to the following questions:

1. What is the desired loan amount?
2. Do you want to make monthly or quarterly payments?
3. What is the date of the loan?
4. What interest rate do you want (most people use 4%)?
5. Name of person taking out the loan.
6. Address for the person taking out the loan.

Once we receive the above information, we will prepare the loan document and the loan amortization schedule. We will then send them to you for review and signature.

You will then need to submit the loan paperwork to your custodian. Ensure that the receipt of funds is clearly notated as a cash balance plan participant loan.

Loan payments should be made by check from your personal checking account (not the cash balance plan investment account) payable in the name of the cash balance plan.

Make sure to write “Participant Loan Payment” on the check memo line. If you are doing an automatic transfer, make sure it is clearly notated. As trustee of the plan, deposit the loan payment checks into the cash balance plan bank or investment account.

The trustee must track the loan payments. The loan amortization schedule and the retirement plan bank account statements serve this purpose.

Make sure you report to us any default under the payment terms and we will issue a 1099-R at the end of the year.

Our plan document calls for interest to be charged at prime + 1%.

You must charge interest on the loan at a reasonable rate. The interest rate should be consistent with interest rates charged by banks or lenders for a loan made under similar situations. If it meets these criteria, it is considered reasonable. 

Based on recent IRS guidance, the following rates may be considered reasonable: 

•  A CD rate + 2 percent
•  The prime rate + 1 percent

Yes it does. Regulations require that the interest rate be reviewed each time a loan is originated or modified.

As a result, you can’t select a loan rate when the plan is established and use that rate throughout the life of the plan. Loan interest rates should be updated and reviewed as often as required to ensure they are uniform and consistent with lending practices.

Up to 50% of the value of the employee’s account balance can be utilized to secure the loan (subject to the $50,000 limit). This amount is determined at the time the loan is made.

No. As long as the company does not place any restrictions on the use of the loan that would benefit itself or another party in interest, the employee can decide to use the loan proceeds as they see fit.

As a general rule, you are not taxed when you take out the loan. The following conditions must be present to avoid taxation when the loan is made.

1. The plan loan is required to be repaid in full within five years unless the loan is used to buy the employee’s principal residence. 
2. The loan provisions must require substantially equal amortization of principal and interest and payments must be made at least quarterly. As an example, a five-year loan with interest only payments and a balloon payment at the end of the period will not qualify. 
3. The loan must be supported by a legally enforceable agreement.
4. The loan is limited to the lower of: (1) $50,000; or (2) one-half of the employee’s vested accrued benefit.

The loan amount is considered as a taxable distribution. As such, it is subject to a 10 percent early withdrawal penalty if the participant is under age 59 1/2. In that case, code L is used on IRS Form 1099-R to report the distribution.

As a general rule, loans must paid in full within five years from the date of loan. An exception to the five-year rule exists for loans utilized to acquire the employee’s principal residence.

If an employee wants a repayment period longer than five years, the employee must submit a sworn statement from the employee certifying that the loan will be used to purchase the participant’s principal residence.

The law allows a grace period whereby a loan participant can avoid an immediate deemed distribution following a missed payment. The grace period cannot be extended beyond the last day of the calendar quarter that follows the calendar quarter in which the required payment amount was due.

If this deadline is missed, it will be considered a deemed distribution and subject to a Form 1099-R filing.

Yes you can take out multiple loans up to $50,000 less the highest outstanding balances over the previous 12 months of all plan loans outstanding at any time over the previous 12 months. 

For example, assume you (1) had a previously taken out an employee loan with the highest outstanding balance of $8,000 over the previous 12 months; and (2) within the past 12 months, you had taken out a second loan equal to $12,000 and paid it off, you could take out a third loan equal to 50% of the balance up to $30,000.

If a loan defaults, the loan value at the time of default is taxable and reported to the employee and the IRS on Form 1099-R. 

Distribution code L is utilized for defaulted loans when there is no offset of the plan balance due to a plan distribution triggering event. If an offset happens to occur, the actual distribution is then reported as usual (i.e., according to the participant’s age), and code L would not be applicable. The following illustrates the reporting for a defaulted loan.

Phil has a cash balance plan balance consisting of $80,000 in stocks and bonds and $20,000 of outstanding loan assets for a total account balance of $100,000. Phil then defaults on his outstanding loan, which then results in a deemed distribution of $20,000. 

For the year of the default, the third-party administrator will issue a Form 1099-R showing a gross distribution of $20,000 in Box 1 and a taxable amount of $20,000 in Box 2a. The distribution code would be “L” for a loan treated as a deemed distribution without a corresponding loan offset. 

After a few years, Phil closes his business and requests a distribution of his cash balance plan account balance. At such point, the assets consist of $120,000 in cash and the $20,000 outstanding loan balance for a total balance of $140,000. 

Before the distribution, the administrator offsets the $20,000 outstanding loan amount against the $20,000 loan receivable, leaving $120,000 as the final balance valuation. The administrator then issues IRS Form 1099-R showing a gross distribution of $120,000 in Box 1 and a taxable amount of $120,000 in Box 2a.

Cash balance plans are for people who are employees on payroll. So if you are in a corporation, you’ll need a W2 to contribute to a plan.

Generally speaking, you can still run payroll even if you are many months late. But payroll taxes were required to be paid on the subsequent payroll to avoid penalties and interest. So for a calendar year payroll, the payroll taxes should’ve been paid in the first week or two in January.

This being the case, you can still run payroll late. But you will have penalties and interest that will likely be more than 50% of the payroll taxes. In addition, these penalties are not tax deductible.

In most situations, running a late payroll does not make sense because the penalties involved usually exceed the benefits from the cash balance plan contribution.

Before you do anything, I would check with your CPA and payroll provider and see what they think and if this is a route you should consider. Setting up a plan for the subsequent year might make more sense.

Since these plans are only for people who have earned income subject to Social Security and Medicare taxes, you’ll need to generate a W-2 for your spouse if you want to get a contribution into the plan. There can also be entry date restrictions, but we can generally amend the plan to make this work.

Remember that your spouse has to actually work in the business, and the salary you pay needs to be reasonable. So make sure you discuss it with your CPA or tax preparer. But if you’re looking to get more money into a plan to reduce your taxes, getting a contribution in for your spouse can make a lot of sense.

These plans are structured for people who are employees. As such, any person working in the business must have payroll withholdings for Social Security and Medicare.

But whether or not you need to be on payroll depends on your entity structure. If you are a C Corp. or S Corp., you need to generate payroll on a W-2.

But if you are a sole proprietor, you do not have to run payroll. Your business profit is subject to Social Security and Medicare taxes, so that is your deemed earned income.

Also, if you are in a partnership and work in the business, this income would generally be subject to self-employment taxes, and you do not need to have a payroll run or a W-2.

So it depends on your entity structure. If you still have questions, feel free to contact us, and we can help clarify.

Required Minimum Distributions (RMDs) have been around for decades. They are the minimum amounts a retirement plan account holder must withdraw or distribute annually, starting with the year they reach 72.

Retirement plan participants and IRA account owners must calculate and take the correct RMD amount on time each year. The IRS imposes stiff penalties for any failure to take RMDs.

For defined contribution plan participants, or IRA owners, who passed away after December 31, 2019, the entire balance of the participant’s account must be distributed within ten years. The IRS allows an exception for a surviving spouse, a chronically ill or disabled person, or someone not more than ten years younger than the IRA holder or employee. The 10-year rule applies whether or not the person passes away before, on, or after the required beginning date, currently age 72.

As a general rule, you have to take an RMD from your retirement plans even if you are still employed.

However, you could qualify for an exception from withdrawing RMDs from your company sponsored retirement plan if you meet both the below criteria:

• You’re still employed; and
• You do NOT own more than 5% of the company.

If you meet both the above criteria, you can delay taking an RMD from the company plan until April 1st of the year after you retire. However, these rules do not apply to IRAs. If you continue working past the age of 72, you will have to take an RMD from your IRA account.

You are required to take your first RMD for the year you turn age 72. However, you can delay the first RMD payment until April 1st of the year following the year you turn 72.

For the subsequent years, including the year you received the first RMD by April 1st, you must distribute the RMD by December 31st of the year.

As a general rule, your RMD is calculated for each qualifying retirement account by dividing the previous December 31st balance by the life expectancy factor as published by the IRS publishes in the respective Tables in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). Select the life expectancy table based on your current circumstance.

Joint and Last Survivor Table II – this table isused if the account’s sole beneficiary is your spouse and your spouse is over ten years younger than you are.

• 2022 RMDs

Uniform Lifetime Table III – this table is utilized if your spouse is not the sole beneficiary or if your spouse is not more than ten years younger

• 2022 RMDs

Single Life Expectancy Table I – this table is used if you are the beneficiary of an applicable retirement account (an inherited IRA)

• 2022 RMDsPDF

See the IRS worksheets to calculate the RMDs.

The IRA owner is required to calculate the RMD separately for each IRA they have, but the amount can be withdrawn from the total amount from one or more of the IRA accounts.

However, RMDs that are required from other retirement plans, such as 401(k) profit-sharing plans, cash balance plans and other defined benefit plans, must be withdrawn separately from each of those plan accounts.

While the IRA custodian or plan administrator will often calculate the RMD amount, the retirement plan account owner is ultimately responsible for properly calculating the RMD amount.

Yes. The IRS establishes a minimum amount that can be withdrawn. The retirement plan owner can withdraw as much as they want.

If an account owner fails to withdraw an RMD, withdraw the total amount of the RMD, or remove the RMD by the required deadline, the amount not withdrawn is taxed at a rate of 50%. The retirement account owner must file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with their individual federal tax return for the year in which they did not take the total RMD amount.

Yes, the IRS may waive the penalty if the owner establishes that the withdrawal shortfall was the result of reasonable error and that they will take reasonable steps to remedy the shortfall. To qualify for this penalty relief, you must file IRS Form 5329 and attach a statement of explanation to the tax return. See the instructions for Form 5329.

No. The account older is not allowed to carryover any amount in excess of the RMD to the following year.

The retirement plan owner is taxed at their ordinary tax tax rate on the withdrawn amount. However, if the RMD amount is a return of basis or a qualified distribution from a Roth IRA, it is tax-free or taxed based on the pro-rated amount.

No. You are not allowed to rollover the RMDs to another tax-deferred account.

We send our administration invoices in April of each year. This invoice covers the annual administration for the prior year. Here are the following timelines and deadlines to consider:

1. Invoices will go out on approx. April 15th for the prior year administration. For example, you will be billed in April 2023 for the 2022 plan year.
2. You will have 45 days to pay. Emailed invoice reminders will go out every two weeks. For example, you would be billed on April 15^th and receive a reminder on May 1^st, May 15^th and so forth.
3. A late fee of $50 will be assessed for each month the invoice is open starting on June 1^st. So, if you pay the invoice during June you will have a late fee of $50, July late fee is $100, August $150 and so forth.

Please also realize that payment must be received before July 31^st if you want us to file an extension for your IRS Form 5500 filing.

We bill our set up fee upfront when the plan is drafted. If you are setting up a plan during the calendar year that you establish it for, your annual administration will be billed in April of the following year.

If you are setting up a plan for the prior calendar year, you will be billed upfront for both the set up fee and annual administration.

Annual administration covers all actuarial certifications, IRS filings and plan reporting. Going forward, the annual administration is due each April when we begin working on all annual administration.

Unfortunately, no. Our billing process does not allow you to wait until you file your tax return. This is for the following reasons:

1. During April, we begin our internal client processing. This includes updating your plan file, rolling forward funding contributions, and performing our internal review. So we start working on your plan even before you have funded.
2. Our actuary must run your numbers and spend time calculating your funding range. We need to receive payment in advance of this process. There must be ample time between receiving payment, providing your funding range, making your contribution, and filing your tax return.
3. IRS Form 5500 is required to be filed by July 31st. While we can extended this deadline, we need to prepare the extension request and must receive payment in advance.
4. Lastly, as you are aware, these are permanent plans and so you are subject to mandatory funding requirements. You cannot “elect out” or change your mind. So annual administration is required.

Of course, we can make exceptions for clients under unusual situations like being ill, overseas travel, death in the family, etc. Just let us know if you have any questions.

Annual funding amounts are determined based on a variety of criteria including age, compensation (or business income) and investment returns. If you are looking to make higher contributions, you should consider the following:

1. Increase your wage. If you do not have employees, then typically you can get your W2 up to $230,000. That is generally the highest applicable compensation. If you have employees, then you should consider increasing your W2 up to $290,000.
2. Consider adding a spouse. If your spouse works for your business then you should consider including them on payroll and/or increasing their compensation. This can also allow them to get a defined benefit plan contribution and possibly make a 401k contribution as well.
3. Review your investment mix. Remember that these plans use an implied interest rate of 5%. If your assets earn more than this, it will tend to push your contributions lower. Make sure that aggressive and volatile investments are held in your 401k plans and IRAs.
4. Consider certain insurance products. While these are not always the best investments, they can reduce plan assets and allow for larger contributions.

Remember that these plans are just one part of your tax and retirement strategy. Make sure you review the items noted above with your CPA and financial advisor.

There are several deadlines that you should be aware of:

Plan Set Up Deadline:

Defined benefit plans must be set up before you file your tax return (including extensions). But the latest date is Sept 15th. Remember that drafting your plan documents will take approximately one week and then you will need to open your investment account and fund it. So you should allow yourself at least a month to get it all accomplished.

In order to take advantage of the employee deferral on 401k plans, you must have it set up before December 31st. If you have employees, you likely will need a safe harbor 401k plan and the deadline to set up these plans is Sept 31st.

Funding Deadline: