Discuss all of the following statements and state why you agree or disagree with

Question

Discuss all of the following statements and state why you agree or disagree with each of them individually.

1. A defined benefit plan can help an older controlling employee in a small business maximize tax-deferred savings.

2. The Internal Revenue Code sets a maximum limit on the projected annual benefit that a defined benefit plan can provide.

3. An employee cannot be covered under both a defined benefit and a defined contribution plan.

4. Defined benefit plans that use the flat amount formula provide a retirement benefit that is a percentage of the employee’s average earnings

Explanation / Answer

1. A defined benefit plan can help an older controlling employee in a small business maximize tax-deferred savings.

True. Defined benefit plans are ideal for clients with high earned income and are either self-employed or small business owners with 4 or less full time employees.

Defined benefit plans may be beneficial to older employees who may feel they are behind with their accumulated savings for retirement and need (or want) to make significant contributions to accumulate assets rapidly over a relatively short period of time.

100% of the contributions are made by the employer. Contributions are generally 100% tax deductible (within IRS limits).

Small business owners with employees must make contributions for eligible employees. Employees do not contribute to a defined benefit plan. When a defined benefit plan is setup eligibility requirements can be established such as 1 year and a 1000 hours of service so part time employees that do not meet the requirement are not included in the plan.

2. The Internal Revenue Code sets a maximum limit on the projected annual benefit that a defined benefit plan can provide.

True. The defined benefit plan limit is based on the benefit to be received at retirement, not on the annual contribution. Each year the plan’s actuary determines the required annual contribution based on several factors such as age, salary level and years of service, as well as interest rate assumptions. The maximum annual benefit for which a plan may fund is 100% of the participant’s compensation up to $210,000.

3. An employee cannot be covered under both a defined benefit and a defined contribution plan.

False. However, certain limits are imposed at both the individual plan level and at the combined plans level. In combining plans, an employer would not normally adopt more than one plan of the same type.

Individual Plan Limits

At the individual plan level, the maximum annual retirement benefit permitted under a defined benefit plan for a participant is the lesser of 100% of compensation or $195,000. The maximum allocation to a participant under a defined contribution plan is the lesser of 100% of compensation or $49,000.If an employer adopts two plans of the same type, they would be aggregated for the purposes of these limits.

Combined Plan Deduction Limits

If an employer maintains both a defined contribution and a defined benefit plan at the same time, the individual plan limits apply separately to each type of plan. However, in some situations, there is also an overall limitation to the deduction allowed to an employer for the combined plans. If the defined benefit plan is subject to coverage by the Pension Benefit Guaranty Corporation (PBGC), then effective for 2008 and later plan years, there is no combined plan deduction limit, only the individual limits. If the defined benefit plan is not subject to the PBGC coverage, then if any employee participates in both plans, the maximum employer deduction is limited to the greater of 25% of the total compensation of all employees participating in either plan, or the minimum required contribution of the defined benefit plan. This limit applies to employer paid contributions, including pension, profit sharing, and matching contributions. Employee 401(k) salary deferral contributions are not subject to the 25% deduction limit. Employer -paid contributions to a defined contribution plan that do not exceed 6% of total compensation of all employees participating in the defined contribution plan do not count toward this 25% deduction limit.

4. Defined benefit plans that use the flat amount formula provide a retirement benefit that is a percentage of the employee’s average earnings

False. Flat Amount Formula - Stated simply, the Plan provides a flat dollar amount to each plan participant. For example: $1,000.00 a month for life. Many union plans provide a flat dollar amount per month for each year of the Participant’s service.

Flat Percentage Formula - Typically provides the Participant with a retirement benefit based on the Participant's average earnings. For example: the formula may provide that the Participant receive 50% of his/her average earnings prior to retirement. A participant with a final average salary of $75,000.00 would receive $37,500.00 at retirement.

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