My business is my main asset

MY BUSINESS IS MY MAIN ASSET

I WANTBENEFITING TO RETIRE FROM A PLAN

A Business Owner’s Guide to the Best Plan by Mary Read CPC, CPFA, QPA

MY BUSINESS IS MY MAIN ASSET

I WANTBENEFITING TO RETIRE FROM A PLAN A Business Owner’s Guide to the Best Plan by Mary Read CPC, CPFA, QPA

© Copyright 2018. All Rights Reserved.

Mary Read CPC, CPFA, QPA National Director of Pension and Protection Planning Pentegra 802-477-2018 • mary.read@pentegra.com Pentegra 701 Westchester Avenue, Suite 320E, White Plains, NY 10604 • 800-872-3473 www.pentegra.com Library of Congress Control Number: 2018902809 ISBN 9780692081549

Table of Contents Chapter 1: Succession – Defying the Odds . . . . . . . . . . . . . . . 5 Chapter 2: What is Your Plan for Retirement? . . . . . . . . . . . . 7 Chapter 3: What Do You Want? . . . . . . . . . . . . . . . . . . . . . . 9 Chapter 4: But I Have Employees . . . . . . . . . . . . . . . . . . . . 11 Chapter 5: I Want What I Want . . . . . . . . . . . . . . . . . . . . . . 15 Chapter 6: Defined Contribution Plans . . . . . . . . . . . . . . . . 19 Chapter 7: Defined Benefit Plans . . . . . . . . . . . . . . . . . . . . . 25 Chapter 8: Hybrid Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Chapter 9: IRA Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Chapter 10: I Own More Than One Business . . . . . . . . . . . . . 39 Chapter 11: Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Chapter 12: Plan Funding . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Chapter 13: I’m Ready to Retire . . . . . . . . . . . . . . . . . . . . . . 53 Chapter 14: It’s Time to Take Distributions

Can I Lower the Tax Bill? . . . . . . . . . . . . . . . . . 57 Chapter 15: What Does a Third Party Administrator Do? . . . . 61 Chapter 16: Action Steps . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Appendix A Key Dates . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Appendix B Taxable Term Cost . . . . . . . . . . . . . . . . . . . . . . 67 Appendix C Stretch IRA . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Appendix D 401(k) Automatic Enrollment . . . . . . . . . . . . . 70 Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 COLA Increases for Dollar Limitations . . . . . . . . . . . . . . . . 74 Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 About the Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Don Martin is the owner of Don’s Precision Machining a small successful business operating with 5 employees.

Don opened his doors for business when he was 40, and with his hard work his business has thrived. At age 67, after 27 years in business, Don has decided he is ready for retirement. None of his children want to take over the business so Don has been seeking a buyer.

What happens now?

With a depressed economy and a shortage of available credit, Don has not been able to find a buyer for his business. With only his house and limited other assets he has determined he needs to continue to work and retirement is not in his immediate future.

What could have happened?

Don’s Precision Machining had established a defined benefit plan when Don was 45. The plan funded retirement benefits and all the plan contributions were deductible on his business tax return. At age 67 Don is able to take a lump sum of $2.4 million from his defined benefit plan. Don can roll the money to an IRA where it can continue to grow tax-deferred and he will pull out enough money each year to cover his living expenses. Don will sell off the equipment from his company when he is able to find a buyer and add to his pool of money for retirement.

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A Less Fortunate Don

Everything does not always go as we planned. Instead of thriving Don had the misfortune to become ill twelve years into running his business, at age 52. In declining health Don found it increasingly difficult to continue his active role in the business. Don tried to sell the business but was not able to find a buyer willing and able to pay an acceptable price.

After two years of struggling Don succumbed to his illness, leaving behind his wife of 25 years, three children and his other dependent family, his employees.

What happened next?

Don had no retirement plan and no life insurance. Upon his death his wife Suzanne stepped in and took over operation of the business.

She did not have Don’s knowledge or skill, however, and the business failed within 2 years. With no other source of income Suzanne had to find other employment to support herself and her children.

What could have happened next?

Don’s Precision Machining had established a defined benefit plan when Don was 45. The plan funded retirement benefits and also included life insurance. Upon Don’s death Suzanne received a $1 million lump sum retirement benefit from the plan plus $1.5 million of income tax-free death benefit from the life insurance. Due to the financial protection from the defined benefit plan, along with the life insurance proceeds, Don’s wife was financially secure.

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Are You Prepared For Reality?

Most closely held businesses have no transition plan and maintain no retirement plan.

Only 35% of businesses survive the first generation1. Will yours?

These failures are not surprising considering what independent data tells us. Only 1%² of businesses with fewer than 10 employees maintain a defined benefit plan, the most secure of retirement plans.

And 41% of all Americans have no life insurance at all3.

Can Failure Be Avoided?

You can transition from active business owner to happy retiree. It just takes planning. This book will attempt to lay out the planning path for you in terms you can understand so that you can make educated choices. Walking the path doesn’t need to be complicated.

What do you want to happen to your business?

When do you want to retire?

Who needs to be taken care of if you don’t make it to retirement?

Who do you want to transfer your wealth to?

The planning decisions are really quite uncomplicated. The key is, you need to take action and make them.

Source: Wharton Center for Applied Research Richard Hamm Risk Management Ass. 2004 ²U.S. Department of Labor, U.S. Bureau of Labor Statistics, August 2007 National Compensation Survey: Employee Benefits in Private Industry in the United States, March 2009 http://www.bls.gov/ncs/ebs/benefits/2009/benefits_retirement.htm http://www.sba.gov/advo/research/sb_econ2009.pdf 3 LIMRA Facts About Life 2011 http://www.limra.com/newscenter/pressmaterials/IIFOL.pdf 1

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4

Chapter 1: Succession – Defying the Odds

T

ypically, 75% of a business owner’s net worth is in his or her business¹. How do you translate that business value into retirement income?

Before you can comfortably retire you must decide what is going to happen with your business. Are you going to sell it? Liquidate it? Give it to your children? Once you decide, you have to figure out how to make it actually happen.

When an active owner leaves the business, whether by death or during lifetime, turmoil often follows. Family members and remaining owners will be thrust into the void and may have conflicting interests that could tear the business apart. Family members may have an inflated idea of the business value, may need to maintain income, may need to continue other benefits like company provided health insurance, and may even expect to be given a job. Remaining owners may want to increase their salaries because of increased responsibility. They may want to reinvest company profits to expand the business. Employees add another dimension as they lose confidence in the business and worry about their own outcomes. With all these competing factors, will the business continue to be successful? Statistics tell us 65%¹ of businesses will not.

¹Source: Wharton Center for Applied Research Richard Hamm Risk Management Ass. 2004

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What do you want the future story of your business to be?

Having a transition plan in place defines the next chapter of the story.

Whether initiated by retirement, death or disability, a transition plan defines when and how the business will change ownership and what the price for that transfer will be. It creates a ready market for the business and generates sales proceeds to be used to meet retirement income needs or provide income to surviving family members. Even before the agreement is triggered by an event it adds stability to the business by creating clarity about the future.

This transition plan is commonly defined by a buy/sell agreement.

The buy/sell agreement is a written legal contract for the future sale of a business interest. It sets the terms and conditions for the sale and provides the clear path to a willing buyer. Purchase proceeds will convert a business interest into cash quickly for retirement, estate tax and survivor income needs. Among the items a buy/sell agreement should define are the purchase obligation, parties to the agreement, triggering events, the value or valuation process for determining the value of the business, timing of the transaction and method of payment.

In many cases buy/sell agreements are funded with life insurance.

Life insurance has advantages because of the tax-free death benefit and tax-free internal cash accumulation of permanent life insurance policies. • Upon death, life insurance will provide funds available immediately to pay the purchase price • Cash value policies may be used to provide funds in the event of disability or for a lifetime sale* How Do I Create My Transition Plan?

Creating a transition plan requires consulting with your financial advisor to design the plan, an attorney to create the legal documents, and a licensed insurance agent to obtain the needed insurance to fund the plan. You may also need a business valuation.

Step No. 1 in Your Retirement Plan: Establish and fund a transition plan.

*Policy loans and withdrawals will reduce the policy cash value and death benefit and may result in a taxable event.

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Chapter 2: What is Your Plan for Retirement?

T

hink right now. What is your plan for retirement? If you are like most of your peers, your plan is to sell your business when the time comes to retire. What is your alternative plan if you can’t find a buyer or you can’t find a buyer willing to pay what you think is the right price? Will you work longer? Will you retire on less? Are you planning on turning over the business to your child or children to run?

Will they be able to pay you?

Income for retirement can come from the sale of a business, from personal savings, from social security and from a private retirement plan. The sale of any business is subject to multiple factors outside of the owner’s control and can be the most unpredictable part of a retirement plan.

• When it is time to sell your business a buyer may not be available. Market conditions may reduce the value of the business. Credit may not be available for a purchaser to get financing.

• Personal savings are dependent on personal discipline and on the investment performance of the vehicles you invest your savings in.

• Social Security is a topic of much discussion in today’s environment and may remain intact or may be altered in some way not yet defined.

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Private qualified retirement plans were established by the government specifically to enable businesses to create retirement benefits for employees. A qualified retirement plan meets requirements of the Internal Revenue Code and as a result comes with tax advantages and security unavailable in other strategies. Every business owner can establish a private qualified retirement plan to shift assets from their business to their personal wealth.

What is Your Plan for Retirement?

of Sale ss ne Busi Find You Will yer? a Bu ate Priv t Plan en rem Internal i t e R e a) of 401( nue Cod e v Re

ngs Savi l a n o ur Pers t will Yo h? a Wh be Wort gs Savin

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al Soci ty ri Secu ?

Chapter 3: What Do You Want?

Do you want to pay more taxes or less taxes?

Do you want the assets you have accumulated to be at risk of being taken away from you or would you rather have them out of the reach of creditors and raiders?

Do you want the IRS to help you accumulate money or stand in the way?

If you own your own business, want to pay less taxes, want to protect your assets from the reach of creditors and want to accomplish these things with the help and blessing of the IRS, then you need to step onto a path long-established but under-utilized by today’s business owners. That is the path of tax-qualified retirement plans. ➥➥ Tax Deductible ➥➥ Protection from Creditors ➥➥ Retirement Savings Tax-qualified retirement plans were created more than 60 years ago to be a mechanism for providing retirement income for employees.

Any employer contributing to such plans benefited from a current tax deduction for every dollar they contributed. Today’s plans do the same, whether you have a business with 1,000 employees or 1 employee. All plan contributions are tax-deductible, grow taxdeferred and are protected for the plan participants from creditors.

If you are an employee of your business you can be a plan participant.

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The money an individual may pay in income taxes over the next 25 years can translate into savings for retirement!

A business owner earning $175,000 annually pays $50,750 each year in taxes (29% bracket*). Over 25 years this equates to $1,268,750 paid in taxes. If the business adopts a qualified retirement plan and contributes $55,000 the business owner will save $15,950 in current income taxes. Over 25 years this equates to $398,750 of tax savings that are instead put to work for the business owner ($15,950 x 25).

Assuming a 5% interest rate, the tax savings could grow to more than $799,000 for retirement. $799,309* $800,000

Funding for Retirement

$600,000 $400,000 $200,000 $0 -$200,000 -$400,000

-$398,750

Lost Income Taxes

*assuming 24% federal income tax bracket and 5% flat state income tax, married filing jointly tax status using standard deduction.

This example is purely hypothetical and for illustrative purposes only. The numbers assume yearly compounding.

The returns above do not consider inflation, taxes or management expenses which will reduce your return.

The illustrated results are not indicative of any particular situation and your results likely will differ from those shown above. A 5% hypothetical return assumed.

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Chapter 4: But I Have Employees

“I have employees and I can’t afford to contribute for them.”

There are many real reasons to seek not to make plan contributions for employees. But resisting contributing for employees is costing you money. In fact not having a plan could cost you more than having one.

How can that be? ➥➥ If the tax savings you get for contributing to a qualified retirement plan are greater than the amount of contributions that are made for employees, the employees cost you nothing.

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Contributions are not the same as Cost Anderson Architectural Age

Salary

Pat Anderson (Owner)

61

$275,000

Chris Anderson (Spouse)

57

$275,000

Drew Anderson (Child)

32

$ 75,000

Employee 1

27

$ 45,000

Employee 2

62

$ 30,000

Total

$700,000

Drew $6,000

EE1 $2,250

EE2 $1,500

Chris $55,000

Pat $55,000

Profit Sharing Plan Total Contribution

$119,750

Tax Savings

$ 25,147*

Net After Tax Cost of Plan

$ 94,603

Deposit For Pat, Chris & Drew

$116,000

Net Gain

$ 21,397+

* Assumed Tax Rate for the Business 21%

Not doing the plan will cost $25,147 in taxes. Without the tax-deductible plan contribution these taxes will not be saved.

Contributing to the plan creates tax savings of $25,147, of which $3,750 is contributed for the two employees and $21,397 benefits Pat, Chris and Drew. The family receives a total contribution of $116,00 and Uncle Sam paid 20% of it.

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Who has to be in the Plan?

The first step in determining who will be a participant in a plan is to establish requirements for eligibility to participate. The eligibility requirement will be defined in the plan document.

Typically to be eligible an employee must be age 21 and have one year of service with the company. A year of service is an employment year in which the employee works at least 1,000 hours. There is a second option. A plan can require employees to have two years of service to be eligible but once they enter the plan they will be immediately vested in any contributions made for them. This option is not available in 401(k) plans but can be used in any other type of qualified retirement plan. This option is seldom used and most plans will use one year of service and age 21 as their eligibility requirement.

I’m eligible so I’m a participant, right?

No. Just because an employee is eligible does not mean they must participate in the plan. Employees can be excluded from participation in any plan if that is what the employer wants to do. There are participation rules that must be followed, but under the most basic of rules as many as 30% of the rank and file employees can be excluded from the plan.

70% Coverage Test The percentage of Non-highly Compensated Employees (NHCE) participating in the plan must be at least 70% of the percentage of Highly Compensated Employees (HCE) participating in the plan.

HCE is a term defined by pension regulations. See the glossary of this book for a definition. Owners of more than 5% of a business will be HCEs. NHCEs are those employees who do not meet the Highly Compensated Employee definition.

Example 2 Owners (HCE) 10 Employees (NHCE)

Participating Required to Participate

2 7

1 4

In our example we have two owners, perhaps a husband and wife, and ten eligible rank and file employees all of which are NHCEs. If both our owners are eligible and participate in the plan that is 100% and 70% of our 10 eligible rank and file employees must also participate in 13

the plan. If one of our owners does not participate in the plan then we only have 50% of our eligible HCEs participating in the plan and we only have to have 35% (70% x 50% = 35%) of our eligible NHCEs participating in the plan. 35% of 10 is 3.5, but it is not possible for ½ a person to participate, so 4 of the 10 eligible employees must be participants.

How Are Employees Excluded From Participation?

Employees are excluded by language written into the plan document.

Employees must be excluded on a non-discriminatory basis. A typical way is to exclude classes of employees based on employees’ job titles.

Employees may never be excluded by discriminatory factors such as age, race or gender.

When Do Employees Own the Contributions Made for Them?

Employees who become participants and receive contributions earn ownership in those contributions over time. This is called vesting.

In a defined contribution plan, an employer can require that employees have 3 years of service to become 100% vested (cliff vesting) or employers can choose a graduated vesting schedule which provides at least 20% vesting after 2 years, 40% after 3 years, 60% after 4 years, 80% after 5 years, and 100% after 6 years.

In a defined benefit plan, an employer can require that employees have 5 years of service in order to become 100 % vested (cliff vesting) or employers can choose a graduated vesting schedule, which provides at least 20% vesting after 3 years, 40% after 4 years, 60% after 5 years, and 80% after 6 years of service and 100% after 7 years. In Cash Balance Plans, employees must be 100% vested in employer contributions after 3 years.

Plans may provide a different schedule as long as it is more generous than these vesting schedules.

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Chapter 5: I Want What I Want

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he key to favoring yourself and anyone else you might want to favor in a qualified retirement plan is plan design. Not all qualified retirement plans are equal. There are diverse plan types, and within those types, diverse design tools to steer plan contributions to plan participants in various ways. Qualified retirement plans come in two basic types: Defined Contribution and Defined Benefit. The basic difference is Defined Contribution plans define what will be contributed. Defined Benefit plans define the benefit that will be paid in the future.

Plan Type

Defines

Unknown

Defined Contribution Defined Benefit

Contribution Benefit

Benefit Contribution

Qualified Retirement Plan Structure The Employer adopts the qualified retirement plan by signing a plan document. The plan document defines the terms of the plan and creates a trust to hold all the plan assets. The employer makes taxdeductible contributions to the plan which fund benefits for plan participants. While in the plan, all contributions grow tax-deferred.

Taxes will be paid when the benefits are distributed. Taxes may be deferred by rolling the plan benefit into an Individual Retirement Account (IRA). Taxes will then be paid when money is distributed from the IRA. 15

The Structure of a Qualified Retirement Plan

Employer Plan Contribution, Tax deductible

Plan Trust Tax-Deferred Growth IRA Distribution, Taxation

Retirement!

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Distribution, Taxation

Defined Contribution Plans define the amount that will be contributed. The benefit a participant will ultimately receive from the plan is unknown. Think of pulling into the gas station and asking for $20 of gas. You know what you are paying but you don’t know precisely how much gas you will get.

Defined Benefit Plans define the benefit a participant will receive at retirement. The contribution will be whatever is needed to fund that benefit as determined by an actuary. Think of pulling into a gas station and saying “fill it up”. You know you will have a full tank of gas but don’t know exactly what it will cost.

How Do I Get What I Want?

Different plan types and different formulas will control how much each participant gets of the contribution that is made. Defined Benefit Plans generally have much larger contributions than Defined Contribution Plans. Defined Benefit Plans and some types of Defined Contribution plans will favor anyone who is older and has fewer years until retirement. Other Defined Contribution Plans will divide contributions strictly based on pay.

Every Company is Different.

It is important to have a qualified retirement plan that is designed specifically for you. This will involve defining how much you want to contribute and who you want to favor and require an analysis of the full census of all your employees with their salaries, dates of hire and dates of birth. With this information, a plan design specialist will be able to custom design the best plan for you.

Step No. 2 in Your Retirement Plan: Define Your Goals and Establish a Qualified Retirement Plan Custom Designed to Benefit You 17

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Chapter 6: Defined Contribution Plans Defined Contribution Plans define the amount that will be contributed to the plan. What any plan participant will receive when they leave the plan is unknown. Their ultimate benefit is the result of the total contributions made over time and the earnings or losses on those contributions. Each participant has an individual account in a Defined Contribution Plan and bears the risk of investment performance.

These plans are limited in how much the employer can contribute and how much any employee can have allocated to their account each year. These plans may also allow for employee salary deferrals in the form of a 401(k) salary deferral feature.

Employer Maximum Tax-Deductible Annual Contribution Individual Participant Maximum Annual Allocation Participant Salary Deferral Limit Participant Catch-up Deferral For those Age 50 and Older Maximum Compensation that may be recognized

25% of the total payroll of all the plan participants 100% of pay to a maximum of $55,000 (2018)* plus Catch-up Deferral 100% of pay to a maximum of $18,500 (2018)* $6,000 (2018)* $275,000 (2018)*

*Limit adjusted annually

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Profit Sharing ➥➥ Flexible Contributions ➥➥ Can Favor Older and Higher Paid Participants This is the most frequently adopted type of Defined Contribution Plan. All the contributions in this type of plan are made by the employer and contributions are flexible from year to year. The employer can contribute up to 25% of the total payroll of the plan participants in any year or as little as $0. This enables employers to flex their contributions to meet their business and cash flow needs.

Traditionally the Plan Trustee directs all the investments in most Profit Sharing Plans. However, employees can be given the control to direct the investment of their individual accounts.

Once contributions are made to the plan they must be divided among plan participants – this is referred to as allocation in the pension world – based on a formula written in the plan document. This formula must meet non-discrimination rules.

Different formulas can create quite different results. Employers choose which formula method works best for them as part of the plan design and selection process. Some formulas are based solely on pay and some also take age and/or length of service into account.

Profit Sharing Formulas Proportionate to Pay: Everyone receives the same percentage of pay.

Permitted Disparity: This formula takes into account the contributions made by the employer to Social Security and allows an additional allocation for those high paid individuals who are limited by the Social Security Wage Base.

Age Based : This formula gives a higher allocation to older employees because they have fewer years until retirement.

New Comparability: This formula allows the employees to be divided into groups receiving different contribution amounts. Projected benefits under this formula must be comparable but not equal.

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Anderson Architectural Age

Salary

Pat Anderson (Owner)

61

$275,000

Chris Anderson (Spouse)

57

$275,000

Drew Anderson (Child)

32

$ 75,000

Employee 1

27

$ 45,000

Employee 2

62

$ 30,000

Total

$700,000

Proportionate to Pay EE1 $9,000

Permitted Disparity

EE2 $6,000

Drew $12,726

Drew $15,000

EE1 $7,635

EE2 $5,090

Pat $55,000

Pat $55,000 Chris $55,000

Chris $55,000

Total Contribution = $140,000 % for Owner & Family = 89.3%

Total Contribution = $135,451 % for Owner & Family = 90.6%

Age Based

New Comparability

EE1 $1,350 Drew $2,250

EE2 $9,022

Chris $55,000

Drew $6,000

Pat $55,000

Total Contribution = $122,622 % for Owner & Family = 91.5%

EE1 $2,250

Chris $55,000

EE2 $1,500

Pat $55,000

Total Contribution = $119,750 % for Owner & Family = 96.8%

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401(k) ➥➥ Employee Salary Deferrals ➥➥ Participant Directed Accounts A 401(k) Plan is a Profit Sharing Plan with the added feature of employee salary deferrals. Salary deferrals may be pre-tax or aftertax (Roth Deferrals). In addition to employee salary deferrals, 401(k) Plans typically include a company match and an optional employer profit sharing contribution. 401(k) Plans are the most common type of employee benefit plan used today and are the most recognized plans by employees. Most 401(k) Plans allow the plan participants to direct the investment of the funds in their plan accounts.

Because 401(k) Plans are Profit Sharing Plans with the added salary deferral feature, 401(k) Plans are subject to the same rules as Profit Sharing Plans with additional rules for how much the employee can contribute.

Employer Maximum Tax-Deductible Annual Contribution

25% of the total payroll of all the plan participants, excluding employee salary deferrals

Individual Participant Maximum Annual Allocation, Including the Employee Salary Deferrals

100% of pay to a maximum of $55,000 (2018)*

Participant Salary Deferral Limit

100% of pay to a maximum of $18,500 (2018)*

Participant Catch-up Deferral For Those Age 50 and Older

$6,000 (2018)* may be contributed above the $18,500 salary deferral limit. This $6,000 is also above the $55,000 individual allocation limit enabling a plan participant who is age 50 or older to potentially get a total allocation of $61,000.

An employee is eligible for the catch-up if they turn age 50 any time during the calendar year.

*Limit adjusted annually

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Limitation on Deferrals 401(k) salary deferrals for Highly Compensated Employees (HCE) are limited by the Actual Deferral Percentage (ADP) test. This test defines how much the Highly Compensated Employees can defer based on how much all the other employees defer. Those employees who could defer but don’t count as zero in the test bringing the average deferral rate for the employee group down. The lower the average percentage deferred by the rank and file employees the less the Highly Compensated Employees will be able to defer. A company match can be offered to encourage employees to defer larger amounts.

Roth 401(k) Salary Deferrals Roth deferrals are salary deferrals that are made after-tax rather than before-tax as traditional 401(k) salary deferrals are. The income limitations that apply to Roth IRAs do not apply to Roth 401(k) salary deferrals. Any employee eligible to make salary deferrals in a 401(k) Plan may choose to make some or all of those deferrals as Roth deferrals if the plan offers that option. Roth deferrals can be rolled to a Roth IRA and can be eligible for tax-free distribution in the future.

Deferral limits are the same as for traditional 401(k) salary deferrals.

Safe Harbor 401(k) A Safe Harbor 401(k) Plan is a 401(k) Plan that escapes certain tests, including the Actual Deferral Percentage test. This means Highly Compensated Employees (HCE) can defer what they choose, regardless of what the rank and file employees defer. In order to qualify as safe harbor, the employer must make a mandatory contribution either as a 100% match on the first 3% each employee defers and 50% on deferrals between 3 and 5% of pay, or as a flat 3% contribution for all eligible participants. The employer mandatory contribution is 100% immediately vested. Optional profit sharing contributions can be made and can be subject to a vesting schedule.

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Automatic Enrollment Automatic Enrollment allows an employer to automatically deduct elective deferrals from an employee’s wages unless the employee makes an election not to contribute or to contribute a different amount. Any plan that allows elective salary deferrals can have this feature. Employers must give employees the option to make an election before any deferrals are withheld from their wages.

Employees may also have the option to withdraw their money within 90 days of the date that the first automatic contribution was made, depending on the plan. This is governed by the plan document.

See Appendix D for Automatic Enrollment options.

401(k) for One 401(k) Plans can be very appealing to self-employed individuals who have no rank and file employees. When there are only owners in the plan, whether it is one or more than one, the Actual Deferral Percentage test does not apply and the plan is much simpler to maintain. Each participant can defer as much as they like up to the allowable limit and receive a profit sharing contribution enabling them to reach the maximum allowable amount of 100% of pay up to $55,000. If they are age 50 or older they may also add a catch-up contribution. This can be particularly attractive for individuals who have second sources of income which they do not need to cover living expenses and would prefer to shelter from taxes.

401(k) For One Taxable Compensation $100,000

Total $49,500

Catch-up Deferral $6,000 (over Age 50)

$50,000 $45,000 $40,000

Total $25,000

$35,000

401(k) Deferral $18,500

$30,000 $25,000 $20,000 $15,000 $10,000

Profit Sharing Contribution (25% of Pay)

SEP Contribution (25% of Pay)

$5,000 $0

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SEP

401(k)

Chapter 7: Defined Benefit Plans

D

efined Benefit Plans are the most misunderstood of all the qualified retirement plans. The first type of qualified retirement plan ever created, Defined Benefit Plans provide a promised benefit at a specified retirement age. The benefit is defined in the plan document and funding that benefit is the obligation of the employer.

The plan participant bears none of the investment risk and can know at any time what they will receive at retirement.

Defined Benefit Plans can be expensive and have lost their appeal for many large employers. But for closely held businesses they can be an effective tool for making large tax-deductible plan contributions and will fund the largest amounts for those closest to retirement.

Maximum Annual Benefit

Lesser of: 100 % high 3 consecutive year average compensation or $220,000 per year paid as a life annuity (2018)*

Employer Maximum Tax-Deductible Annual Contribution

No dollar limit. Contributions can be whatever is actuarially required

Maximum Compensation That May Be Recognized

$275,000 (2018)*

*Limit adjusted annually

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Employers will typically consider a Defined Benefit Plan when they want to contribute more than the amount allowed in a Profit Sharing Plan or have a need to accumulate larger sums for retirement than is possible in a Profit Sharing Plan in a limited amount of time.

A 55 Year Old Planning To Retire At Age 65 Compare the Annual Tax-Deductible Contribution Traditional Defined Benefit $149,243

Profit Sharing $55,000

Compare the Accumulation at Age 65 Traditional Defined Benefit $2,487,517

Profit Sharing $730,590

Profit Sharing Plan assumes $55,000 annual contribution growing at 5% for 10 years. Traditional Defined Benefit amount is value required at retirement to pay the defined monthly benefit. The above example is purely hypothetical and for illustration purposes only. The example shown above does not represent the setup of any particular plan and your results likely will differ. Contributions are actuarially determined and may change based on actual experience. The lump sum payments under a Defined Benefit Plan are limited by the provisions of IRC417(e) and IRC415(GATT). The lump sum total is actuarially determined and assumes the defined monthly benefit is paid as a single life annuity.

26

Types of Defined Benefit Plans: Traditional ➥➥ Large Contributions ➥➥ Future Promised Benefits This is the original defined benefit plan. The plan has a benefit formula that defines the benefit to be paid at a specified retirement age typically between age 62 and 65. For example, the plan might define a participant’s benefit as 20% of pay or 1.5% of pay for each year of service. Traditional Defined Benefit Plans come in two types: Safe Harbor – Everyone will be under the same benefit formula.

General Tested – Employees can be divided into groups with each group having a different benefit formula. Typically used with slightly larger groups in order to favor select participants and keep contributions for non-select participants to a minimum.

27

Anderson Architectural Age

Salary

Pat Anderson (Owner)

61

$275,020

Chris Anderson (Spouse)

57

$275,000

Drew Anderson (Child)

32

$ 75,000

Employee 1

27

$ 45,000

Employee 2

62

$ 30,000

Total

$700,000

Salary

Contribution

Pat

$275,000

$205,625

Chris

$275,000

$165,857

Drew

$ 75,000

$3,494

Employee 1

$ 45,000

$1,316

Employee 2

$ 30,000

$23,380

Total

$700,000

$399,672

Family %

93.8% Total Contribution $399,672

$400,000 $350,000 $300,000

Current Tax Savings* $83,931

$250,000 $200,000 $150,000 $100,000

Net After-tax Cost $315,741

Contribution for Employees $24,696

Contribution for Owner & Family $374,976

$50,000 0$

*21% tax rate This example is purely hypothetical and for illustrative purposes only. The example shown above does not represent the actual results of any particular plan and your results will likely differ.

28

Fully Insured 412(e)(3)* ➥➥ Fully Guaranteed ➥➥ Large Tax-Deductible Contributions This type of Defined Benefit Plan is permitted under § 412(e)(3) of the Internal Revenue Code. The 412(e)(3) Plan must be funded only with guaranteed level premium annuity contracts and level premium whole life insurance. Individual contracts are issued on each plan participant and minimum guarantees* are provided in the contracts eliminating market risk. Because funding of the benefits is based on the guarantees in the contracts, Fully Insured 412(e)(3) Plans frequently generate the largest tax-deductible plan contributions.

412(e)(3) Fully Insured Defined Benefit Plans have been around for more than 60 years. Their popularity rises and falls with people’s confidence in the stock market and their willingness to accept risk.

412(e)(3) Plans eliminate market risk because the funding contracts have minimum guarantees. 412(e)(3) Plans can never be over or under funded and the contributions are predictable. Some employers and participants also find them easier to understand since a plan participant’s benefit at any time is equal to the value of the underlying contracts. Fully Insured 412(e)(3) Plans typically work best for small companies with very few or no employees other than the owner. If there are employees it is preferable that the owner is older and the employees younger and lower paid.

412(e) (3) ANNUITY & LIFE INSURANCE Annual Annual Contribution Contribution Without Life With Life Insurance Insurance

Insurance Death Benefit

Lump Sum at Retirement

Age

Salary

Owner Pat

61

$275,000

$276,059

$373,691

$3,875,673 $1,303,191

Owner Chris

57

$275,000

$263,365

$331,122

$4,739,079 $2,038,027

Employee 1

27

$45,000

$11,013

$9,996

$550,437

$714,809

Total

$829,958

$521,099

*412(e)(3) Plans were formerly known as 412(i) plans. Originally established under section 412(i) of the Internal Revenue Code they were moved to Code Section 412(e)(3) by the Pension Protection Act of 2006. Guarantees dependent upon the claims-paying ability of the issuing company.

29

412(e) (3) AFTER TAX ANALYSIS Total Contribution $714,809 Current Tax Savings* $150,109

Net After Tax Cost $564,700

Contribution for Employee $9,996

Contribution for Owners $704,813

21% tax rate*

COST OF LIFE INSURANCE Total Contribution $714,809

Insurance Premiums $330,229 ($323,622 for owners)

Contribution Increase Over Annuity Only $164,372 ($129,853 after tax cost)

Annuity Only $550,437

Insurance Death Benefit Owner Pat

$3,875,673

Owner Chris $4,739,079 EE1

$829,958

This example is purely hypothetical and for illustrative purposes only. The example does not represent the actual results of any particular plan and your results likely will differ.

30

Chapter 8: Hybrid Plans

H

ybrid plans blur the line between Defined Contribution and Defined Benefit Plans by incorporating features of each. Cash Balance plans are currently the most popular of the hybrid plans and are gaining popularity among employers.

Cash Balance ➥➥ Large Contributions ➥➥ Benefit Defined as Account ➥➥ Can be Particularly Effective when Combined with 401(k) Plan The Cash Balance Plan is actually a Defined Benefit Plan subject to Defined Benefit Plan rules for the maximum and minimum benefit provided and the contributions permitted. The difference is that instead of the benefit formula defining a benefit payable at a retirement age, the benefit formula defines a benefit comprised of Contribution Credits and Interest Credits credited to a hypothetical account for the participant each year. The plan appears to create an account for each plan participant similar to a Profit Sharing or 401(k) Plan but there is no actual account and the Plan Trustee has full responsibility for investment of the assets. The participant’s final benefit will be the total of the Contribution Credits and Interest Credits credited to their account each year.1

Subject to minimum benefit requirements.

1

31

These plans can be designed to separate plan participants into groups with each group receiving a different Contribution Credit rate. They can also be combined with a 401(k) Profit Sharing Plan, placing some plan participants in the Cash Balance Plan and some in the 401(k) Profit Sharing Plan. This design strategy is commonly used as a means to control the contribution amounts for employees and favor chosen employees.

Anderson Architectural Age

Salary

Pat Anderson (Owner)

61

$275,000

Chris Anderson (Spouse)

57

$275,000

Drew Anderson (Child)

32

$ 75,000

Employee 1

27

$ 45,000

Employee 2

62

$ 30,000

Total

$700,000

Pat

Cash Balance Contribution 401(k) Credit Deferrals $209,000 $24,500

Profit Sharing & 3% Safe % of Harbor Total Total $18,000 $251,500 53.57%

Chris

$159,000

$24,500

Drew

0

$5,625

$2,250

$7,875

1.68%

Employee 1

$2,925

$0

$2,250

$5,175

1.10%

Employee 2

$1,950

$0

$1,500

$3,450

0.73%

$372,875

$54,625

$42,000

Total:

32

$18,000 $201,500 42.92%

$469,500 100.0%

Chapter 9: IRA Plans

S

impler tax-deductible retirement savings plans are available in the form of SEP and SIMPLE plans. These are IRA plans and exist under a different section of the Internal Revenue Code than the qualified retirement plans we have already talked about. Qualified retirement plans that are funded with a trust – profit sharing, 401(k), money purchase, defined benefit, 412(e)(3) fully insured and cash balance – are established under Section 401(a) of the Internal Revenue Code.

The IRA plans are established under IRC Section 408(h). Why does that matter? Because the different code sections establish different rules making trusteed qualified plans and IRA plans quite different. IRA plans are generally attractive for their simplicity and their inexpensive cost to set up and administer. It is not necessary to have a third party plan administrator (TPA) and the documents to establish the plan are available free from the government forms website. What is given up in return is the ability to custom design the plan to meet specific employer objectives and the ability to make larger contributions.

33

Simplified Employee Pension (SEP) The SEP is funded exclusively by employer contributions. The contributions are tax-deductible to the employer and are deposited in individual IRA accounts owned by each plan participant. The contribution limit for a SEP is 25% of the payroll of the participants in the plan. This is the same as a Profit Sharing Plan. Once contributed the only way to allocate the money is in proportion to pay, so everyone will receive the same percentage. No one can ever receive more than 25% of pay or more than $55,000 in 2018*.

Employer Maximum Tax-Deductible Annual Contribution

25% of the total payroll of all the plan participants

Individual Participant Maximum Annual Allocation

25% of pay to a maximum of $55,000

What is different from a Profit Sharing Plan?

• Everyone must always get the same percentage of pay • All contributions are immediately vested and belong to the participants since they are deposited in IRA accounts • Part-time employees cannot be excluded. Anyone who worked 3 out of the last 5 years must be included, regardless of the amount of hours they worked. A minimum earnings amount for a year worked does apply in the current year only. For 2018 the minimum earnings requirement is $600*.

• All eligible employees must be included • Life insurance may not be included because it is not allowed in any IRA Now for the good news SEP plans can be established up until the employer files their tax return, including extensions, while a Profit Sharing Plan must be established by the end of the fiscal year. SEP plans have no commitment for ongoing contributions. Lastly SEP plans do not require a third party plan administrator and can be operated by the employer. *Limit adjusted annually.

34

Anderson Architectural Age

Salary

Pat Anderson (Owner)

61

$275,000

Chris Anderson (Spouse)

57

$275,000

Drew Anderson (Child)

32

$ 75,000

Employee 1

27

$ 45,000

Employee 2

62

$ 30,000

Total

$700,000 SEP Contributions

Pat

$55,000

Chris

$55,000

Drew

$15,000

Employee 1

$9,000

Employee 2

$6,000

Total

$140,000

Family %

89.2% EE1 $9,000

EE2 $6,000

Drew $15,000 Pat $55,000 Chris $55,000

Total Contribution = $140,000 % for Owner & Family = 89.2%

Saving Incentive Match Plan For Employees (SIMPLE) The SIMPLE is a simplified version of a 401(k) Plan for employers with no more than 100 employees. Like a 401(k) Plan employees can make pre-tax deferrals. There is a mandatory employer contribution which may either be a match or a flat percentage. Both the employee salary deferral and the employer contribution are deposited in individual IRA accounts owned by the plan participants. Employees can defer any 35

amount they choose up to the maximum. Employer contributions are not flexible and must be made in the amount required.

SIMPLE Participant Salary Deferral Limit

$12,500 (2018)* $3,000 catch-up for those age 50 and older (2018)*

Employer Tax-Deductible Annual Contribution

2% of pay for all eligible employees, or 100% match up to 3% of pay Match may be reduced to as low as 1% in 2 out of 5 years

Distributions

Taxed as ordinary income.

If taken prior to age 59 ½ may be subject to an additional 10% federal income tax penalty.

If taken within the first 2 years of plan participation, federal income tax penalty 25%.

Eligibility

Age 21 2 year service requirement No minimum hours Minimum compensation $5,000

*Limit adjusted annually

36

Establishing a SIMPLE Plan SIMPLE plans must be established no later than October 1 of the first year. No other qualified plan may be maintained in any year the employer has a SIMPLE plan. SIMPLE plans may be established with Form 5304-SIMPLE (http://www.irs.gov/pub/irs-pdf/f5304sim.pdf).

Anderson Architectural Age

Salary

Pat Anderson (Owner)

61

$275,000

Chris Anderson (Spouse)

57

$275,000

Drew Anderson (Child)

32

$ 75,000

Employee 1

27

$ 45,000

Employee 2

62

$ 30,000

Total

$700,000

SIMPLE Salary Deferral

Catch-up

Employer Match

Total

Pat

$12,500

$3,000

$8,250

$23,750

Chris

$12,500

$3,000

$8,250

$23,750

Drew

$12,500

$2,250

$14,750

Employee 1

$1,350

$1,350

$2,700

Employee 2

$900

$900

$1,800

$21,000

$66,750

89.2%

93.2%

Total

$39,750

$6000

Family %

EE2 $1,800

EE1 $2,700

Drew $14,750

Pat $23,750

Chris $23,750

37

38

Chapter 10: I Own More Than One Business

Y

ou’ve been successful and you’ve invested in another business.

Congratulations! But, beware of how your other business interests might affect your planning.

The IRS, like the three musketeers, takes the view that it is “all for one” when it comes to multiple businesses owned by the same person or small group of people. When there is significant common ownership or some common ownership and a significant business connection, multiple companies must be treated as one for qualified retirement plan purposes. This means you may not set up a plan for your medical practice and ignore the restaurant that you own.

39

There are two sets of rules that must be considered in determining what companies and employees must be pulled together when a qualified retirement plan or SEP or SIMPLE is put in place: the Controlled Group rules and the Affiliated Service Group rules.

Controlled Group Rules These are simple ownership rules. If you own controlling interest in more than one company those companies will be pulled together and treated as one. The form of business is irrelevant. The rules apply to incorporated and unincorporated businesses.

A controlled group exists if there is: 1. A parent-subsidiary group of businesses connected through at least 80 percent ownership, or 2. A brother-sister group in which a. Five or fewer people own 80 percent or more of the stock value or voting power (controlling interest) of each business, and b. The same five or fewer people together own more than 50 percent of the stock value or voting power (effective control) of each business, taking into account the ownership of each person only to the extent such ownership is identical with respect to each organization. [ I.R.C. §§ 414(b), 414(c), 1563(a), 1563(f)(5) ; United States v. Vogel Fertilizer Co., 455 U.S. 16 (1982)]

Affiliated Service Group Rules These rules are subjective as they depend on the business relationship between organizations that have any amount of common interest.

They only apply to companies that provide services. For a firm determination or whether or not an Affiliated Service Group exists a determination letter must be requested from the IRS. An affiliated service group consists of a service organization (FSO) and one or both of the following: 1. A service organization (A-ORG) that is a shareholder or partner in the FSO and that either regularly performs services for the FSO or is regularly associated with the FSO in performing services for third persons.

40

2. Any other organization (B-ORG) if a significant portion of the business of the B-ORG is the performance of services for the FSO or the A-ORG (or for both) of a type historically performed in the service field of the FSO or the A-ORG by employees and 10 percent or more of the interests in the B-ORG is held by individuals who are HCEs of the FSO or A-ORG. [ I.R.C. ยง 414(m) ; Rev. Rul. 81-105, 1981-1 C.B. 256]

If you have ownership in more than one company seek the advice of a qualified retirement plan specialist to determine whether you have a Controlled or Affiliated Service Group before adopting a plan. Failure to follow these rules could result in disqualification of your plan.

41

42

Chapter 11: Protection 4 out of 201

Will DIE before age 65 For those who make it

100%

WILL DIE at age 65 or older

Q

ualified retirement plans are permitted to include life insurance.

Purchasing needed life insurance through a qualified retirement plan can be advantageous because the premiums are paid with taxdeductible plan contributions. This means insurance can be purchased with fewer out-of-pocket dollars.

Do I Need Life Insurance?

There is always the risk of dying prematurely. Life insurance can make a plan self-completing in the event of premature death ensuring that the retirement benefits participants planned to have for retirement will be there for beneficiaries. There may also be needs for life insurance outside the qualified retirement plan that can be met by buying insurance in the plan at a lower cost.

What About Employees?

Life insurance in a qualified retirement plan must always be provided on a uniform and non-discriminatory basis. All employees must have the same insurance product. The insurance can be whole life or universal life. Term insurance is allowed but generally not used because there is no financial advantage when term insurance is used.

Participants always have the right to waive coverage.

1 http://www.census.gov/prod/1/pop/p23-190/p23190-g.pdf

43

Defined Contribution Plans In Defined Contribution Plans the employer can choose to include insurance in the plan by requiring coverage to be provided to each plan participant or by offering the insurance and allowing each participant to choose whether they do or do not want the insurance. In Defined Contribution Plans premiums are paid out of the dollars contributed to each participant’s account. For example, a participant may receive a contribution of $10,000 of which $1,000 will pay the life insurance premium and $9,000 will go to investments.

Cost A $1,000 life insurance premium would require taxable earnings of about $1,408 for someone in a 29% tax bracket. Inside the qualified retirement plan there are no income taxes. Using $1,408 of plan contribution, $1,000 pays the premium and the $408 can be invested for retirement.

Funds Income tax 29% Premium Available for Investment in the plan

Outside Plan $1,408 (408) $1,000 0

Inside Plan $1,408 0 $1,000 $ 408

Defined Benefit Plans When life insurance is included in Defined Benefit Plans all participants must be provided with the insurance. Participants do not make an election. Because the retirement benefit is always defined in a Defined Benefit Plan, the addition of insurance will increase the plan contribution by an actuarially determined amount. This is good news for some employers who are seeking the maximum possible deductible plan contribution.

44

Defined Benefit Plan Current age 55 $3,338,330 Life Insurance

Retirement age 65 Premium $56,875

Plan contribution Lump sum at retirement Life insurance death benefit

No Life Insurance $149,243 $2,431,072 $0

With Life Insurance $152,188 $2,431,072 $3,338,330

Outside the qualified retirement plan a premium of $56,875 would require personal earnings of $80,105 for someone in a 29% tax bracket. Inside the Defined Benefit Plan the insurance adds just $2,945 to the required plan contribution. The plan contribution is fully tax-deductible. In a 29% tax bracket this means an after-tax cost of $2,090.

Total Contribution $152,188 Insurance Premium $56,857

Contribution Increase Over Fund Only $2,945 Per Year

Fund Only Contribution $149,243

The above example is purely hypothetical and for illustrative purposes only. The example shown above does not represent the setup of any particular plan or insurance contract and your results likely will differ. Contributions are actuarially determined and may change based on actual experience. Compensation $275,000 45

Economic Benefit Cost Whenever life insurance is included in a qualified retirement plan the insured participant is receiving an immediate benefit in the form of the life insurance protection. The value of this benefit is reported and added to the participant’s taxable income each year. The amount reported on the participant’s W-2 is not the actual premium but is an “economic benefit” cost for the pure death benefit coverage. Pure death benefit coverage is the difference between the death benefit provided by the life insurance policy and the cash value of the policy.

The “economic benefit” reported is determined using IRS Table 2001 (IRS Notice 2001-10), see Appendix A, or if the insurance company that issued the policy meets requirements defined by the IRS, they may use their own term insurance rates. The insurance company will provide this information to the company sponsoring the plan each year.

How Much Insurance is Allowed?

Insurance must be incidental to any qualified retirement plan.

Insurance is incidental if the following rules are followed.

Defined Contribution Pension Plans Of plan contributions, these amounts may be used to pay insurance premiums: • 25% of aggregate contributions1 for Universal Life insurance • Less than 50% of aggregate contributions1 for Whole Life insurance Profit Sharing Plans have more generous rules that also apply. Profit Sharing Plans can use 100% of these amounts to pay premiums.

• Contributions and earnings accumulated in the account for more than 2 years • A participant’s entire account after 5 years of plan participation • Funds rolled over from an IRA

Aggregate incudes all contributions made to date.

1

46

Defined Benefit Pension Plans The amount of insurance must meet one of these two limits.

• The death benefit equals no more than 100 times the projected monthly pension amount. Example: If a participant will receive a $1,000 monthly benefit at retirement the maximum face amount of life insurance can be $100,000 or • Internal Revenue Code Ruling 74-307 Percentage Test (Percentage of Theoretical Uninsured Cost) —— Up to 33.3% of Theoretical Uninsured Cost may be used for Universal Life premium —— Up to 66.6% of Theoretical Uninsured Cost may be used for Whole Life insurance premium This method typically results in higher allowable insurance amounts than the 100 times rule.

At Retirement At retirement the life insurance policy must be removed from the qualified retirement plan. This can be accomplished in four ways.

• Surrender the contract.

The death benefit is eliminated. The cash value remains in the plan and can be rolled to an IRA or taken as cash.

• Distribute the contract.

Death benefit and cash value are preserved. Tax is paid on the fair market value minus the cumulative reportable “economic benefit” costs.

• Purchase the contract.

The participant pays the fair market value of the policy to the plan in cash and the policy ownership is changed to the participant. Death benefit and cash value remain. No taxation.

• Exchange the contract.

Offered by some insurance companies. The policy may be surrendered in the plan leaving the cash value in the plan to be rolled to an IRA or distributed as cash. A new contract is issued on the insured outside the plan.

47

Benefits at Death If an insured participant dies their beneficiary will receive the benefit they have accrued in the plan plus the life insurance death benefit.

When life insurance is included, the pure death benefits provided by the life insurance policy will be paid income tax free. The cash value of the policy and any accrued benefit paid will be subject to income tax. The “economic benefit� costs paid over the life of the policy may be claimed as cost basis against the taxable cash value of the policy.

$1,400,000 $1,200,000

$1,000,000

$1,000,000

Insured Death Benefit

$800,000 $600,000

Accrued Benefit

Accrued Benefit

$400,000 $200,000 $0

$173,837

$173,837

Plan Without Insurance

Plan With Insurance

Business owner age 52 establishes a Defined Benefit Plan funding for the maximum benefit allowed at age 65. Death occurs at age 55.

48

Fair Market Value Whenever a life insurance policy is distributed or sold from a qualified retirement plan its value must be determined. Prior to February 13, 2004, the “value” of a life insurance policy was either the policy’s cash surrender value or, in certain cases, the policy reserves. However, the IRS grew concerned with the use of what were commonly referred to as “springing cash value” policies which were distributed with very low cash values that would later jump to a much greater amount, thus avoiding taxes at the time of distribution. As a result, after February 12, 2004, the value used for the policy is the “fair market value” which is the policy cash value and all other rights under such contract. Rev. Proc. 2005-25, 2205-17 I.R.B. 962 provides a safe harbor formula for valuing a life insurance policy. The safe harbor value for a policy is “the greater of A or B.” “A” is the sum of the interpolated terminal reserve (a number which must be obtained from the insurance company) and any unearned premiums, plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience. “B” differs depending on the type of policy.

It is a formula which can be summarized as “PERC” (Premiums + Earnings - Reasonable Charges) times a certain permitted factor for surrender charges. The formulas basically disallow excessive, waivable, or “disappearing” surrender charges as an offset against value.

The formula provided by Rev. Proc. 2005-25 is a safe harbor but is not required to be used. Taxpayers may choose to determine fair market value by another method such as getting an appraisal of the policy from an independent company that is in the business of evaluating insurance policies.

Step No. 3 in Your Retirement Plan: Consider Protecting Your Benefit 49

50

Chapter 12: Plan Funding

E

ach year the employer has the opportunity to make tax-deductible contributions to their qualified retirement plan. In order to deduct the plan contribution, the contribution must be made before the business tax return is filed for the year. This includes extensions. A business with a calendar tax year will file their tax return sometime in the following year, perhaps as late as October. This can provide an extended period of time in which to make plan contributions. Defined Benefit Plans and Money Purchase Plans are limited in the time in which contributions must be made to no later than 8 ½ months after the close of the plan year, regardless of extensions. Employers can always contribute earlier and may choose to do so to get their money working for them in the plan sooner.

Profit Sharing Plans have the most flexible contributions. Each year the employer can contribute anywhere from zero to 25% of participating payroll and contributions can be made up until they file their tax return with no time limit. This flexibility can be very attractive enabling the business to adjust their contribution each year based on their needs and cash flow.

Defined Benefit Plans require a contribution each year, unless the plan has become fully or overly funded. An actuary will calculate the amount that must be contributed. The contribution must be made.

If the company is suffering severe financial hardship they can apply to the IRS for a waiver of the contribution. The waiver will extend the time in which the contribution may be made but will not eliminate it.

Money is invested by the Plan Trustee. The Plan Trustee or Trustees are fiduciaries and are responsible for the assets of the plan. They 51

must act prudently in the interest of the participants and generally must be bonded. The trust may invest in almost anything except collectibles. Holdings of company stock and company real property are limited in the plan.

Plans with participant directed accounts, such as most 401(k) plans, generally offer a diverse menu of investment funds. Fiduciary liability can be limited in these plans if certain guidelines are met including offering at least three diverse options each with different risk and return factors.

IRAs are not permitted to own life insurance. Since SEPs and SIMPLEs use IRA accounts these plans cannot include life insurance.

Step No. 4 in Your Retirement Plan: Fund Your Plan 52

Chapter 13: I’m Ready to Retire

Y

ou’ve reached retirement. You’ve succeeded in achieving your goals. What do you do with your qualified retirement plan now?

The Plan If you are shutting down your business you will be terminating your qualified retirement plan. Terminating the plan means that all the money in the plan will be distributed to the plan participants, a final filing will be made with the IRS and the plan will cease to exist.

If the business will continue because you are selling the business or passing it on to your children the plan can continue and be modified to better fit the new business situation, or it can be terminated.

53

Benefits At retirement your plan benefit will be distributed. Pension laws require that the normal form of benefit for a single person is a life annuity and for a married person, a joint and survivor annuity1. This does not mean you must take your benefit in this form. The forms that the benefit can be paid in are defined by the plan document.

Some might be: • Joint and survivor annuity • Annuity with a period of years guaranteed (term certain) • Lump sum If benefits are going to be paid as an annuity, the plan must remain in effect to make the payments or an annuity that will make the payments must be purchased from an insurance company. It is often preferable to pay the benefit as a lump sum which can then be rolled to an IRA where it can continue to grow tax-deferred. If you are married, your spouse must consent to the lump sum distribution because they are giving up the plan protection of the survivor annuity.

When the accumulated retirement funds are distributed from the plan they are subject to income tax, unless taxation is deferred by rolling the funds to an IRA. The retirement assets are also subject to estate taxes when they apply.

Required Minimum Distributions At age 70 ½ Required Minimum Distributions must begin. This rule applies to all traditional and rollover IRAs, SEP and SIMPLE plans and also to all qualified retirement plans. It does not apply to Roth IRAs. Qualified plan participants can postpone taking distributions past age 70 ½ if they are still working. They will need to begin their distributions when they retire. This extension does not apply to owners of more than 5% of the business. Failure to distribute the required minimum amount subjects the individual to an excise tax equal to 50% of the amount they should have distributed but didn’t.

The amount that will have to be distributed each year is calculated by dividing an account’s year-end value by the applicable distribution period or life expectancy. Tables are found in Internal Revenue Service Publication 590.

Profit Sharing and 401(k) Plans may be exempt from survivorship rules if certain conditions are met.

1

54

The Required Minimum Distribution rules do not apply to Roth IRAs. For those who have deferred salary into a Roth 401(k) account, rolling those funds into a Roth IRA will remove them from the Required Minimum Distribution requirement. If the funds stay in the 401(k) Plan they will be subject to the Required Minimum Distribution rules.

Early Distributions Amounts distributed from qualified retirement plans or IRAs prior to age 59 ½ are generally subject to a 10% excise tax in addition to any income tax. The 10% excise tax does not apply if the payments are part of a series of payments over the lifetime of the participant or if the distribution is on account of disability or retirement at age 55 or later. Once started, these payments must continue for at least 5 years and until the recipient achieves age 59 ½. If the distributions are stopped or changed before reaching this goal everything distributed will be treated as distributed before age 59 ½ and be subject to the 10% penalty, (IRS Code section 72(t)).

Stretch IRA Retirement amounts rolled to an IRA can remain in the IRA until Required Minimum Distributions must begin and can be passed to a beneficiary at death. This strategy is commonly referred to as a “stretch IRA”. The money in the IRA will continue to grow taxdeferred until it is distributed. If the IRA is a Roth IRA there will be no taxes payable on the distributions if the distributions are “Qualified Distributions”. A qualified distribution includes a distribution from a Roth IRA that is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA and made because of death.

55

Stretch IRA Owner’s birth date

November 15, 1946

Owner’s life expectancy

26.5 years, IRS Uniform Lifetime Table

Owner’s age at death

80

Benefactor’s age at death

85

Previous year ending value

$500,000

Annual rate of return

5.00%

Beneficiary birth date

February 21,1968

Beneficiary relationship

child

Total projected distributions during owner’s lifetime:

$233,737.04

Total projected distributions during beneficiary’s lifetime:

$1,107,208.86

Total projected distributions:

$1,340,945.90

See Appendix C for details

Step No. 5 in Your Retirement Plan: Make a Distribution and Wealth Transfer Plan 56

Chapter 14: It’s Time To Take Distributions.

Can I lower the Tax Bill?

M

oney accumulated in a qualified plan or IRA is income taxable at your personal rate when it is distributed, whether during your life or upon your death. Required Minimum Distributions at age 70 1/2 make sure that you cannot defer taxation indefinitely.

The tax treatment cannot be changed. However, there is a unique strategy utilizing the tax treatment of life insurance that can reduce the tax that will be owed. When life insurance is owned and then distributed from a qualified plan it is taxed at its market value, per IRS Revenue Procedure 2005-25. Depending on the life insurance policy used this taxable value can be substantially less than the cash deposited in the policy. Once the policy is paid for and distributed from the qualified plan it is personally owned and treated the same as any individually owned life insurance policy. Loans can be taken from the policy to provide tax-free income, the policy will provide an income tax-free death benefit to beneficiaries and some policies provide tax-free benefits for use during the insured’s lifetime in the event of terminal, chronic or critical illness or injury.

57

Profit Sharing or 401(k) Plan Payments to Policy

IRA Rollover

Tax Deductible Employer Contributions

Life Insurance Policy

IRA $$$ Taxable Distribution P.E.R.C. Rev Procedure 2005-25

Life Insurance Policy Tax Free Income

Tax Free Death Benefit Living Benefits

The life insurance strategy can lower taxes, increase benefits and remove the qualified money from the Required Minimum Distributions requirement.

58

Qualified Money Benefit to Heirs Insurance Benefit to Heirs

$ 630,000 $ 3,446,280

Qualified Money

$1,000,000 IRA

Tax on IRA

$ 370,000

Insurance in Qualified Plan

Premiums Paid $ 1,000,000

P.E.R.C. Market Value at Distribution $ 747,443

Tax on market Value

$ 276,553

Taxes Saved

$

93,447

When money remains in the IRA taxes are paid on the account growth over time.

Insurance Total Income Taxes Paid

IRA Total Income Taxes Paid

$2,000,000 $1,730,322 $1,800,000 $1,503,450

$1,637,989

$1,600,000 $1,336,313 $1,400,000 $1,150,162 $1,200,000 $957,823 $1,000,000 $800,000 $600,000 $400,000

$287,065

$287,065

$287,065

$287,065

$287,065

$287,065

$200,000 $0

Age 75

Age 80

Age 85

Age 90

Age 95

Age 100

59

60

Chapter 15: What Does a Third Party Administrator Do?

O

nce you have decided that a qualified retirement plan is for you,the plan has to be established and kept compliant with ever changing IRS requirements. There is ongoing testing to be done and there are reports to file. For legal purposes, the Plan Administrator is typically the employer or an officer of the employer. Actual administration of the plan is generally done by a Third Party Administrator (TPA). A Third Party Administrator is a servicer outside the employer who is hired to perform the administration services of the plan.

Third Party Administrator firms can be large or small. It is important 61

that you choose an administrator you are comfortable working with and have confidence in. Allowing your plan to go out of compliance could result in disqualification of the plan and the disallowance of the tax deductions for plan contributions.

Third Party Administrators charge fees for their services similar to other professional service providers. Typically the client signs a service agreement that defines the services and the fees to be paid.

The fees paid to the Third Party Administrator are tax-deductible as a business expense. Additionally, if a plan is the first plan adopted by an employer the government extends a tax credit for startup costs for the first three years of the plan. The credit equals 50% of the costs to set up and administer the plan and educate employees about the plan, up to a maximum of $500 per year for each of the first 3 years of the plan. To qualify for the credit, the employer must have had 100 or fewer employees who received at least $5,000 in compensation for the preceding year. At least one plan participant must be a non-highly compensated employee.

Third Party Administrator Services ➥➥ Plan Design ➥➥ Document Creation ➥➥ Plan Implementation ➥➥ Administration & Recordkeeping ➥➥ Calculation of Employer Contributions ➥➥ Regulatory Compliance ➥➥ Government Reporting, including Form 5500 ➥➥ Reconciliation of Trust Assets ➥➥ Advisor & Plan Sponsor Reporting ➥➥ Participant Education & Communication ➥➥ Calculation and Processing of Employee Plan Benefit Payments The professional you work with to design and fund your plan can usually refer you to a quality Third Party Administrator. CPA’s generally do not provide qualified plan administration services beyond a simple one person plan.

No. 6 in Your Retirement Plan: Hire a Plan Administrator 62

Chapter 16: Action Steps

A

re you ready to plan for your transition from active business owner to happy retiree? After reading this book you are now better prepared to answer these questions and build your personal plan.

What do you want to happen to your business?

When do you want to retire?

Who needs to be taken care of if you don’t make it to retirement?

Who do you want to transfer your wealth to?

You can build your plan in these six simple steps. Get ready and begin.

Step No. 1: Establish and fund a transition plan Step No. 2: Define your goals and establish a qualified retirement plan custom designed to benefit you Step No. 3: Consider protecting your benefit with life insurance Step No. 4: Fund your plan Step No. 5: Make a distribution and wealth transfer plan Step No. 6: Hire a Third Party Administrator to maintain your plan

Give yourself the retirement you deserve.

63

This information is not intended as tax or legal advice. Please consult with your Attorney or Accountant prior to acting upon any of the information concerning your own situation.

64

Appendix A Key Dates April 15

Last day to return excess deferrals to be taxed in prior year

April 15

Last day for IRA contributions

July 31

Form 5500 due for calendar year plans

September 15

Funding deadline for calendar year Defined Benefit and Money Purchase Plans

October 1

Last day to establish a SIMPLE plan for the current year

October 1

Last day to establish a Safe Harbor 401(k) for the current year

December 31

A new plan must be adopted by the last day of the fiscal year. For most businesses that is December 31. The plan is adopted when the employer signs the plan document.

65

66

Appendix B Taxable Term Cost Table 2001 Interim Table of One-Year Term Premiums For $1,000 of Life Insurance Protection Section 79 Extended and Interpolated Annual Rates

Attained Age

Attained Age

Section 79 Extended and Interpolated Annual Rates

Attained Age

Section 79 Extended and Interpolated Annual Rates

0

$0.70

34

$0.98

68

$16.92

1

$0.41

35

$0.99

69

$18.70

2

$0.27

36

$1.01

70

$20.62

3

$0.19

37

$1.04

71

$22.72

4

$0.13

38

$1.06

72

$25.07

5

$0.13

39

$1.07

73

$27.57

6

$0.14

40

$1.10

74

$30.18

7

$0.15

41

$1.13

75

$33.05

8

$0.16

42

$1.20

76

$36.33

9

$0.16

43

$1.29

77

$40.17

10

$0.16

44

$1.40

78

$44.33

11

$0.19

45

$1.53

79

$49.23

12

$0.24

46

$1.67

80

$54.56

13

$0.28

47

$1.83

81

$60.51

14

$0.33

48

$1.98

82

$66.74

15

$0.38

49

$2.13

83

$73.07

16

$0.52

50

$2.30

84

$80.35

17

$0.57

51

$2.52

85

$88.76

18

$0.59

52

$2.81

86

$99.16

19

$0.61

53

$3.20

87

$110.40

20

$0.62

54

$3.65

88

$121.85

21

$0.62

55

$4.15

89

$133.40

22

$0.64

56

$4.68

90

$144.30

23

$0.66

57

$5.20

91

$155.80

24

$0.68

58

$5.66

92

$168.75

25

$0.71

59

$6.06

93

$186.44

26

$0.73

60

$6.51

94

$206.70

27

$0.76

61

$7.11

95

$228.35

28

$0.80

62

$7.96

96

$250.01

29

$0.83

63

$9.08

97

$265.09

30

$0.87

64

$10.41

98

$270.11

31

$0.90

65

$11.90

99

$281.05

32

$0.93

66

$13.51

33

$0.96

67

$15.20

67

Appendix C Stretch IRA Owner’s birth date

11/15/1946, Age 71 as of 12/31/2017

Owner’s life expectancy

26.5 years, IRS Uniform Lifetime Table

Owner’s age at death

80 as of 12/31/2026

Plan type

Traditional IRA

Previous year ending value

$500,000.00 as of 12/31/2016

Annual rate of return

5.00%

Beneficiary birth date

02/21/1968, Age 49 as of 12/31/2017

Beneficiary relationship

child

Beneficiary’s age at death

85 Age at Year End

Prior Year End Cash Value

Life Expectancy

Required Minimum Distribution

Owner

71

$500,000.00

26.5

$18,867.92

2018

Owner

72

$506,132.08

25.6

$19,770.78

2019

Owner

73

$511,667.90

24.7

$20,715.30

2020

Owner

74

$516,536.00

23.8

$21,703.19

2021

Owner

75

$520,659.61

22.9

$22,736.23

2022

Owner

76

$523,956.36

22.0

$23,816.20

2023

Owner

77

$526,337.98

21.2

$24,827.26

2024

Owner

78

$527,827.62

20.3

$26,001.36

2025

Owner

79

$528,217.64

19.5

$27,088.08

2026

Owner

80

$527,540.44

18.7

$28,210.72

As of December 31

Recipient

2017

Total to Owner $233,737.04 2027

Beneficiary

59

$525,706.74

26.1

$20,142.02

2028

Beneficiary

60

$531,850.06

25.1

$21,189.25

2029

Beneficiary

61

$537,253.31

24.1

$22,292.67

2030

Beneficiary

62

$541,823.31

23.1

$23,455.55

2031

Beneficiary

63

$545,458.93

22.1

$24,681.40

2032

Beneficiary

64

$548,050.48

21.1

$25,973.96

2033

Beneficiary

65

$549,479.04

20.1

$27,337.27

2034

Beneficiary

66

$549,615.72

19.1

$28,775.69

68

2035

Beneficiary

67

$548,320.82

18.1

$30,293.97

2036

Beneficiary

68

$545,442.89

17.1

$31,897.25

2037

Beneficiary

69

$540,817.78

16.1

$33,591.17

2038

Beneficiary

70

$534,267.50

15.1

$35,381.95

2039

Beneficiary

71

$525,598.93

14.1

$37,276.52

2040

Beneficiary

72

$514,602.36

13.1

$39,282.62

2041

Beneficiary

73

$501,049.86

12.1

$41,409.08

2042

Beneficiary

74

$484,693.27

11.1

$43,666.06

2043

Beneficiary

75

$465,261.87

10.1

$46,065.53

2044

Beneficiary

76

$442,459.43

9.1

$48,621.92

2045

Beneficiary

77

$415,960.48

8.1

$51,353.15

2046

Beneficiary

78

$385,405.35

7.1

$54,282.44

2047

Beneficiary

79

$350,393.18

6.1

$57,441.50

2048

Beneficiary

80

$310,471.34

5.1

$60,876.73

2049

Beneficiary

81

$265,118.18

4.1

$64,662.97

2050

Beneficiary

82

$213,711.12

3.1

$68,939.07

2051

Beneficiary

83

$155,457.61

2.1

$74,027.43

2052

Beneficiary

84

$89,203.06

1.1

$81,093.69

2053

Beneficiary

85

$12,569.52

0.1

$13,198.00 Total to Beneficiary $1,107,208.86

Total projected distributions: *All distributions are assumed to be taken at the end of the year.

$1,340,946.90

69

Appendix D Automatic Enrollment Options Types of Automatic Enrollment 1. Basic automatic enrollment (Automatic Contribution Arrangement or ACA): • Employees are automatically enrolled in the plan unless they elect otherwise • Plan document specifies the percentage of wages that will be automatically deducted • Employees can elect not to contribute or to contribute a different percentage of pay 2. Eligible automatic contribution arrangement (EACA): • Uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice • May allow employees to withdraw automatic contributions, including earnings, within 90 days of the date of the first automatic contribution 3. Qualified automatic contribution arrangement (QACA): • Uniformly applies the plan’s default deferral percentage to all employees after giving them the required notice • Meets additional “safe harbor” provisions that exempt the plan from annual actual deferral percentage and actual contribution percentage nondiscrimination testing requirements • Default deferral percentage starts at 3% and gradually increases to 6% with each year that an employee participates. The default percentage cannot exceed 10%.

• Required employer contributions. Pick either: —— matching contribution: 100% match for elective deferrals that do not exceed 1% of compensation, plus 50% match for elective deferrals between 1% and 6% of compensation; or 70

—— nonelective contribution: 3% of compensation for all participants, including those who choose not to make any elective deferrals.

• Employees must be 100% vested in the employer’s matching or nonelective contributions after no more than 2 years of service • Plan may not distribute any of the required employer contributions due to an employee’s financial hardship 4. Default investments if employee does not make an election: • Employers must choose an investment for employees’ automatically deducted salary deferral contributions.

Plan fiduciaries can limit their liability for plan investment losses by choosing default investments for deferrals that meet certain criteria for transferability and safety, such as a life-cycle fund or balanced funds Qualified Default Investment Alternative (QDIA). Employees must be given an opportunity to change the investment choice.

71

72

Resources Tax Information for Sponsor/Employer http://www.irs.gov/retirement/sponsor/index.html A Guide to Common Qualified Plan Requirements http://www.irs.gov/retirement/article/0,,id=112858,00.html 401(k) Resource Guide http://www.irs.gov/retirement/sponsor/article/0,,id=151800,00.html Form 5500 Corner http://www.irs.gov/retirement/article/0,,id=117588,00.html Publication 560, Retirement Plans for Small Business, SEP, SIMPLE and Qualified Plans http://www.irs.gov/publications/p560/index.html Resources – IRA Based Plans http://www.irs.gov/retirement/article/0,,id=111406,00.html Publication 590, Individual Retirement Arrangements http://www.irs.gov/pub/irs-pdf/p590.pdf

73

COLA Increases for Dollar Limitations on Benefits and Contributions The Internal Revenue Code provides for dollar limitations on benefits and contributions under qualified retirement plans. Code ยง415 requires the limits to be adjusted annually for cost-of-living increases.

2018

2017

2016

IRAs IRA Contribution Limit

5,500

$5,500

$5,500

IRA Catch-Up Contributions

1,000

1,000

1,000

IRA AGI Deduction Phase-out Starting at Joint Return

101,000

99,000

98,000

63,000

62,000

61,000

600

600

600

55,000

54,000

53,000

275,000

270,000

265,000

12,500

12,500

12,500

3,000

3,000

3,000

Single or Head of Household SEP SEP Minimum Compensation SEP Maximum Contribution SEP Maximum Compensation

SIMPLE Plans SIMPLE Maximum Contributions Catch-up Contributions

401(k), 403(b), Profit-Sharing Plans, etc.

Annual Compensation Elective Deferrals

275,000

270,000

265,000

18,500

18,000

18,000

6,000

6,000

6,000

55,000

54,000

53,000

1,105,000

1,080,000

1,070,000

220,000

215,000

210,000

Catch-up Contributions Defined Contribution Limits ESOP Limits

Other HCE Threshold

120,000

120,000

120,000

Defined Benefit Limits

220,000

215,000

210,000

Key Employee

175,000

175,000

170,000

457 Elective Deferrals

18,500

18,000

18,000

Control Employee (board member or officer)

110,000

105,000

105,000

Control Employee (compensation-based)

220,000

215,000

215,000

Taxable Wage Base

128,400

127,200

118,500

74

Glossary Accrued Benefits: Retirement benefits earned.

In defined contribution plans the accrued benefit will be the amount in the participant’s account; in a defined benefit plan the accrued benefit is determined by the actuary; in a 412(e)(3) defined benefit plan the accrued benefit is equal to the contract values.

Actual Deferral Percentage (ADP) Test: An annual test in a 401(k) plan that compares the average salary deferrals of highly compensated employees (HCEs) to that of non-highly compensated employees (NHCEs). Each employee’s deferral percentage is the percentage of compensation that has been deferred to the 401(k) plan. The deferral percentages of the HCEs and NHCEs are then averaged to determine the ADP of each group.

Allocation: The amount credited to a participant’s account based on the plan formula for dividing and crediting plan contributions.

Annual Report: A report filed annually (Form 5500) with the IRS, DOL and PBGC that reports qualified retirement plan information for the plan year, including such items as participation and funding.

Annuity Contract: A contract issued by an insurance company. The contract may be an investment of the plan or may provide retirement income installment payments.

Automatic Enrollment: Automatically enrolling employees in a 401(k) plan and beginning salary deferrals without an election by the employee once they have completed the eligibility requirements. The plan specifies how much the deferrals will be and where they will be invested. Employees who do not want to make contributions must actively file an election not to defer.

Beneficiary: A person, persons or trust designated to receive a participant’s plan benefits or IRA assets upon death of the participant.

Cash Balance Plan: A type of defined benefit plan that includes some elements that are similar to a defined contribution plan. The benefit amount is computed based on a formula using contribution and interest credits, and each participant has a hypothetical account.

Cash or Deferred Arrangement (CODA): A salary deferral arrangement such as a 401(k).

75

Catch-up Contributions: Contributions above the Salary Deferral limit permitted for those age 50 and older during the plan year. Catchup contributions may be up to $6,000 for 401(k), 403(b) and 457 plans in 2018 (adjusted annually) and $3,000 for SIMPLE plans.

Controlled Group: A group of businesses under common control. A controlled group exists if there is a parent-subsidiary group connected through at least 80 percent common ownership, or a brother-sister group in which five or fewer people own 80% or more of the interest of each group.

Deferral: A pre-tax contribution made from the employee’s pay in a 401(k) or 403(b) plan.

Defined Benefit Plan: An employer-sponsored qualified retirement plan which defines a benefit to be received at a specified retirement age.

Defined Contribution Plan: An employer-sponsored qualified plan in which contributions are made and allocated to individual participant accounts. The ultimate benefit will be the total of contributions and earnings and losses.

Department of Labor (DOL): The U.S. Department of Labor deals with issues related to the American workforce – including topics concerning pension and benefit plans. Through its branch agency the Pension and Welfare Benefits Administration, the DOL is responsible for administering the provisions of Title I of ERISA, which regulates proper administration of qualified retirement plans.

Determination Letter: Letter issued by the IRS formally recognizing that the plan document has been determined to meet the qualification requirements for tax-advantaged treatment.

Distribution: Any payment of plan benefits made from a retirement plan.

Early Withdrawal Penalty: There is a 10 percent early withdrawal federal excise tax on assets distributed from a qualified retirement or IRA plan prior to age 59½ (certain exceptions apply). This excise tax is in addition to regular federal and state taxes due.

Elective Deferrals: Amounts contributed to a plan by the employer at the employee’s election and which, except to the extent they are designated Roth contributions, are excludable from the employee’s 76

gross income. Elective deferrals include deferrals under a 401(k), 403(b), and SIMPLE IRA plan.

Eligibility: Conditions that must be met in order to participate in a qualified retirement plan, such as age or length of service requirements.

Eligible Employees: Employees who meet the eligibility requirements for participation in an employer-sponsored plan.

Employee stock ownership plan (ESOP): A qualified defined contribution plan in which plan assets are invested primarily or exclusively in the securities of the sponsoring employer.

Employer: An employer is generally any entity for whom an individual performs or did perform any service, of whatever nature, as an employee. A sole proprietor is treated as his or her own employer for qualified retirement plan purposes. However, a partner is not an employer for qualified retirement plan purposes.

Instead, the partnership is treated as the employer of each partner.

ERISA (Employee Retirement Income Security Act): A federal law that sets standards of protection for individuals in most voluntarily established, private-sector retirement plans. ERISA requires plans to provide participants with plan information, including important facts about plan features and funding; sets minimum standards for participation, vesting, benefit accrual, and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a claims and appeals process for participants to get benefits from their plans; gives participants the right to sue for benefits and breaches of fiduciary duty; and, if a defined benefit plan is terminated, guarantees payment of certain benefits through a federally chartered corporation, known as the Pension Benefit Guaranty Corporation (PBGC).

Excess Accumulations: The amount that a participant was required to distribute at age 70 ½ but didn’t. Excess accumulations are subject to a 50% penalty tax.

401(k) Plan: A defined contribution plan in which an employee can make contributions from his or her paycheck either before or after-tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the 77

plan. In some plans, the employer also makes contributions such as matching the employee’s contributions up to a certain percentage.

SIMPLE and Safe Harbor 401(k) plans have mandatory employer contribution requirements.

403(b) Plan: A retirement plan offered by public schools and certain tax-exempt organizations. An individual’s 403(b) annuity can be obtained only under an employer’s 403(b) plan. Generally, these annuities are funded by elective deferrals made under salary reduction agreements and non-elective employer contributions.

412(e)(3) Plan: A defined benefit plan that meets the requirements of Section 412(e)(3) of the Internal Revenue Code. These plans must be funded exclusively with level premium annuity contracts and whole life insurance, when life insurance is included. The plan is funded based on the guarantees in the contracts.

Fidelity Bond: Bond required for plan trustees to protect participants in the event a fiduciary steals or mishandles plan assets.

Forfeiture: The non-vested portion of an employee’s account balance (employer contributions) that is lost when the employee terminates employment.

Form 1099R: Form filed with the IRS and sent to the individual receiving a taxable qualified retirement plan distribution.

Form 5500: Annual tax report filed annually with the IRS, DOL and PBGC by qualified plan trusts. Not required for SEPs and SIMPLEs since they are IRA funded plans.

Hardship or In-Service Distribution: Distribution made while still employed. The distribution is taxable and subject to the 10% excise tax if the recipient is under age 59 ½. Permitted in Profit Sharing and 401(k) plans only.

Highly Compensated Employee - An individual who: • Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or • For the preceding year, received compensation from the business of more than $120,000 (2018), and, if the 78

employer so chooses, was in the top 20% of employees when ranked by compensation.

Hybrid Plan: A plan that has features of both defined contribution and defined benefit plans.

Individual Retirement Account (IRA): A way to save for retirement that gives the account holder tax advantages. Contributions made to a Traditional IRA may be tax deductible, depending on income level.

Generally, amounts in a Traditional IRA including earnings and gains, are not taxed until distributed. Roth IRA’s are funded with after-tax dollars but if requirements are met, may be distributed tax-free. Plan participants can transfer money from an employer retirement plan to an IRA when leaving an employer. The 2018 IRA contribution limit is $5,500, $6,500 for individuals age 50 and older. This limit does not apply to rollovers.

Internal Revenue Service (IRS): The branch of the U.S. Treasury Department responsible for administering the requirements of qualified pension plans and other retirement vehicles.

Keogh Plan: A qualified plan sponsored by an unincorporated business. These plans achieved parity with corporate plans in 1982 and are no longer distinguished as Keogh plans.

Key employee: An employee, who at any time during the plan year containing the determination date is: • A more than 5% owner of the employer (family attribution rules apply); • A more than 1% owner of the employer with annual compensation greater than $150,000 (family attribution rules apply); or • An officer with annual compensation greater than $175,000 for 2018.

KSOP: An ESOP with 401(k) features.

Lump-Sum Distribution: The distribution at retirement of a participant’s entire account balance within one calendar year due to separation from service, retirement, death or disability.

Matching Contribution: A contribution made by the employer dependent upon salary deferrals made by the employee. Found in 79

401(k) and SIMPLE plans.

Money Purchase Plan: A plan that requires set annual contributions from the employer to individual participant accounts and is subject to certain funding and other rules. Contributions are not flexible.

Non-Highly Compensated Employees (NHCEs): Employees who are not Highly Compensated Employees. See Highly Compensated Employees.

Participant: An eligible employee who is covered by a qualified retirement plan.

Participant Directed Account: A plan that allows participants to direct the investment of their accounts.

Pension Benefit Guaranty Corporation (PBGC): PBGC is a federal agency created by the Employee Retirement Income Security Act of 1974 (ERISA) to protect pension benefits in private-sector defined benefit plans. If a plan terminates without sufficient assets to pay all benefits, PBGC’s insurance program will pay a benefit up to the limits set by law. Financing comes from insurance premiums paid by companies whose plans are covered by PBGC. Plan Administrator: The person who is identified in the plan document as having responsibility for running the plan. It could be the employer, a committee of employees, a company executive, or someone hired for that purpose.

Plan Document: The legal document that establishes the plan, specifies the terms of the plan and creates the plan trust.

Plan Fiduciary: Anyone who exercises discretionary authority or discretionary control over management or administration of the plan, exercises any authority or control over management or disposition of plan assets, or gives investment advice for a fee or other compensation with respect to assets of the plan.

Plan Loan: Loan from a participant’s accumulated plan assets, not to exceed 50 percent of the vested account balance or $50,000, less the amount of any outstanding loans. This is an optional plan feature in defined contribution plans.

Plan Sponsor: The entity that establishes the plan.

Plan Trustee: Someone who has the exclusive authority and 80

discretion to manage and control the assets of the plan. The trustee can be subject to the direction of a named fiduciary and the named fiduciary can appoint one or more investment managers for the plan’s assets.

Plan Year: A 12-month period designated by a qualified retirement plan for calculating vesting and eligibility, among other things. The plan year can be the calendar year or an alternative period, for example, July 1 to June 30.

Portability: The ability of an employee to transfer pension funds from one employer’s plan to another.

Pre-Retirement Survivor Rights: The right of a surviving beneficiary to receive benefits if a plan participant dies before retirement.

Prohibited Transaction: Activities regarding treatment of plan assets by fiduciaries that are prohibited by ERISA. This includes transactions with a party-in-interest, including, sale, exchange, lease, or loan of plan securities or other properties.

Profit Sharing Plan: A defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise).

The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit sharing plan may include a 401(k) feature.

Prudent Man Rule: ERISA requires that a fiduciary manage a portfolio with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. Any fiduciary violating this law is liable to the plan and its participants for losses.

Qualified Domestic Relations Order (QDRO): A domestic relations order that creates or recognizes the existence of an alternate payee’s right to receive, or assigns to an alternate payee the right to receive, all or a portion of the benefits payable with respect to a participant under a retirement plan, and that includes certain information and meets certain other requirements.

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Qualified Joint and Survivor Annuity (QJSA): An annuity paid as a life annuity (a series of payments, usually monthly, for life) to the participant and a survivor annuity over the life of the participant’s surviving spouse (or a former spouse, child or dependent who must be treated as a surviving spouse under a QDRO) following the participant’s death. The amount paid to the surviving spouse must be no less than 50% and no greater than 100% of the amount of the annuity paid during the participant’s life.

Qualified Plan: Any plan that qualifies for favorable tax treatment by meeting the requirements of section 401(a) of the Internal Revenue Code.

Rollover: A rollover occurs when a participant directs the transfer of the money in his or her retirement account or IRA to a new plan or individual retirement account.

Roth Individual Retirement Account: An IRA that, except as follows, is subject to the rules that apply to a traditional IRA. The account or annuity must be designated as a Roth IRA when it is set up.

• Contributions to a Roth IRA are not deductible.

• If requirements are satisfied, qualified distributions are tax-free.

• Contributions can be made to a Roth IRA after you reach age 70 ½.

• There are no Required Minimum Distributions.

Safe Harbor Rules: Provisions that when met exempt plans from one or more regulations.

Safe Harbor 401(k): A safe harbor 401(k) is similar to a traditional 401(k) plan, but the employer is required to make contributions for each employee. The safe harbor 401(k) eases administrative burdens on employers by eliminating some of the complex tax rules ordinarily applied to traditional 401(k) plans.

Salary Deduction: Also known as payroll deduction. When a plan participant arranges to have pre-tax contributions made directly from their paycheck, it is arranged through salary deduction.

Savings Incentive Match Plan for Employees (SIMPLE): Allows employees and employers to contribute to traditional IRAs set up for 82

employees. SIMPLE plans are only permissible for employers with 100 or fewer employees. SIMPLE plans may be structured as individual retirement accounts (IRAs) or as 401(k) plans.

Self-Employed Individual: An individual in business for himself or herself, and whose business is not incorporated, is self-employed.

Sole proprietors and partners are self-employed.

Simplified Employee Pension Plan (SEP): Allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP. Summary Plan Description (SPD): A document which, in plain language, describes the provisions of the plan and the participant’s benefits and rights under the plan.

Tax Sheltered Annuity (TSA): See 403(b) plan.

Third Party Administrator (TPA): An independent service provider hired by the employer to perform administration services for the plan, including non-discrimination testing, recordkeeping and reporting.

Top Heavy Plan: A plan is top-heavy for any plan year for which the total value of accrued benefits or account balances of key employees is more than 60% of the total value of accrued benefits or account balances of all employees. Additional requirements apply to a topheavy plan, including the requirement that non-key employees receive a minimum contribution and the requirement to satisfy an accelerated vesting schedule for employer contribution accounts. The top-heavy plan requirements do not apply to SIMPLE 401(k) plans. Additionally, the top-heavy rules do not apply to a plan that consists solely of safeharbor 401(k) contributions.

Vesting: The participants’ ownership right to company contributions.

Each employee will vest, or own, a minimum percentage stated in the plan document of their account in the plan each year. When an employee is 100% vested in his or her account balance, he or she owns 100% of it and the employer cannot forfeit, or take it back, for any reason. Amounts that are not vested may be forfeited by employees when they are paid their account balance or when they don’t work more than 500 hours in a year for five years.

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Vesting Schedule: The schedule for determining a participant’s vested right to company contributions. Different plan types have different vesting requirements for employer contributions: • SEP and SIMPLE IRA (and other IRA-based) plans require that contributions to the plan are always 100% vested.

• Qualified defined contribution and defined benefit plans can offer a variety of different vesting schedules that are determined by the plan document. These can range from immediate vesting, to 100% vesting after 3 years of service (as defined by the plan, generally 1,000 hours worked over 12 months), to a vesting schedule that increases the employee’s vested percentage for each year of service with the employer. Employers can choose to use different methods of counting service.

Years of Service – The time an individual has worked in a job covered by the plan. It is used to determine when an individual can participate and vest and how they can accrue benefits in the plan. Generally, a Year of Service requires that an employee accrues at least 1,000 hours of service over a 12-consecutive-month period.

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About The Author Mary Read CPC, CPFA, QPA has more than 30 years of experience supporting financial advisors and designing and establishing qualified retirement plans for closely held businesses. Mary’s expertise has made her a frequent speaker and contributor to financial industry publications. Among her credits she has taught pension classes for financial professionals of major financial institutions and been a featured speaker at national meetings for the Society of Financial Service Professionals, the Association for Advanced Underwriting (AALU), LIMRA and Million Dollar Round Table (MDRT). She is the current National Chair for the Qualified Section of the Society of Financial Service Professionals.

Mary continues her active role in supporting financial professionals and closely held businesses with pension strategies in her present position as National Director of Qualified Plan Marketing at Pentegra Retirement Services. Pentegra has over 65 years of retirement plan experience, providing comprehensive retirement plan solutions to businesses, banks and credit unions. Ranked as one of the top pension providers in the country, Pentegra has a 97+% client satisfaction rating, year after year.

Mary Read CPC, CPFA, QPA National Director of Pension and Protection Planning Pentegra 802-477-2018 • mary.read@pentegra.com Pentegra 701 Westchester Avenue, Suite 320E, White Plains, NY 10604 • 800-872-3473

www.pentegra.com

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Pentegra 701 Westchester Avenue, Suite 320E, White Plains, NY 10604 • 800-872-3473

www.pentegra.com

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Y

ou can transition from active business owner to happy retiree. This book will lay out the planning path for you in terms you can understand so that you can make educated choices. After reading this book you will be better prepared to answer these questions and to build and execute a plan to achieve your goals.

What do you want to happen to your business?

When do you want to retire?

Who needs to be taken care of if you don’t make it to retirement?

Who do you want to transfer your wealth to?

Give yourself the retirement you deserve.

701 Westchester Avenue, Suite 320E, White Plains, NY 10604 www.pentegra.com • 800-872-3473