Guidant Financial Group Blog

5 comments:

Bill Black said...

Part One of Four:

December 15, 2009

The blog of Monday, June 23, 2008, was recently brought to my attention.

First, thank you for mentioning my web site and providing a link in your blog. Perhaps some readers found our web site informative.

However, the reason for the comments is to explain that yes, clients CAN contribute, in some cases, as much as $250,000 annually to their qualified plan. The blog’s misconception is it is “voodoo mathematics.” It is far from that. It is actuarial science. Let me explain.

Your blog’s paragraph “fuzzy math” states: Fuzzy Math. What we do know is that they are layering a defined benefit (DB) plan on top of the existing defined contribution (DC) plan (i.e., 401(k)). This is a misconception number one. Generally, the design is a stand-alone defined benefit (DB) plan.

Further in your blog: Even so, this figure does not crunch. Somebody is exaggerating, somewhere. In essence, it’s marketing fluff. It is significant to note that at the time this posting goes live, the deferral figure promoted on this company’s website is $200,000, not $250,000 (as they promoted at the last convention). The defined benefit plan’s contribution limit is $185,000.

This is the crux of the misconception and misinterpretation. At the time of your writing, the maximum benefit under IRC 415 was $185,000 (now $195,000). But this is the annual benefit, or retirement income stream one may have a retirement. It is not the annual contribution you erroneously assume.

Here’s how it works:

1. Assume your client is age 57 (male or female makes no difference, unisex rates are required.)
2. Assume the DB plan provides the maximum IRC 415 benefit.
3. Question now: How much money does the plan have to reserve, by retirement date of the participant, to provide that benefit? This amount can be determined by mortality tables and interest rate discounts (as dictated to the Actuary by the Service); essentially an annuity purchase rate.
4. The amount required to pay the benefit in this theoretical plan approaches $2 million.
5. The client must now amortize the “Funding Objective,” or amount necessary to provide the benefit, between now (age 57) and retirement age. The contribution could be as high as $268,394, annually.
6. This is far from “voodoo mathematics” or “fuzzy math.” It is certified annually by an Enrolled Actuary licensed to practice before Department of Labor (DOL) and Department of Treasury (DOT). The Enrolled Actuary is required to certify the contribution on the Schedule SB (formerly Schedule B).

December 22, 2009 10:53 AM

Bill Black said...

Part two of four:

Further on your blog: Common Sense. I met a prospect at the International Franchise Expo who asked me about this and I chuckled. I told him that in theory (maybe not as much as the marketing fluff would lead you to believe) it’s possible. I asked him if he expected the business opportunity he was looking at to make him enough to defer $250,000 a year, still pay his bills, and not bleed the company of money. He laughed too. Five minutes later he mentioned he’d call our representative (whom he already was working with) to move forward with Guidant’s services.

This comment is surprising. Yes, many if not most “small businesses” can meet their deduction goals with a DC, or defined contribution plan. Keep in mind small business is the engine of our economy. There are many, many small businesses that come to us with the refrain: “I’m putting the maximum $49,000 (2008 and 2009) into my 401(k) and it is not enough. I need a bigger deduction. No one has any ideas for me.” That’s when we implement the DB plan, and yes, deductions can be up to $200,000, and sometimes higher depending on the circumstances (the average contribution – about $125,000 annually.)

Who are these clients? Aside from the obvious medical practices the examples are endless. It’s the “millionaire next door.” They may not outwardly project wealth, but they have it. And large taxable income in excess of what they need to maintain their lifestyle. For example: Jewelers, Pharmacists, Trucking Companies, Wholesale Companies, Engineering Companies, Construction Companies, Commodity Importers, the list goes on and on.

Think about it this way: For estate tax returns filed in 2007, one out of 73 filed an estate tax return and only one in 163 paid an estate tax, or 0.60% (1 ÷ 163). (http://www.taxpolicycenter.org/briefing-book/key-elements/estate/how-many.cfm) However, are there not entire law firms, departments of law firms, CPA’s and other financial advisors, all of whose practices involve estate planning? Are there not life insurance carriers that develop policies to specifically address this issue? Lobbyists engaged to address this issue? Following the author’s logic, this is such a small slice of the market that it makes no sense to address these needs. Quite the contrary.

While these DB plans may be for the select few, consider this statistic: Less than 4% of the population has Adjusted Gross Income (AGI) in excess of $150,000 (U.S. Census 2007). Those that can use a DB plan are fewer than those that can benefit from a DC. However, that does not invalidate the benefit or merit of a DB plan or make it “voodoo” or “fuzzy.” It is simply something many advisors and practitioners don’t understand or comprehend as it is outside their purview or expertise.

Further, you discuss fees: Administrative and Operational Costs of DB Plan. Here are a couple of fun facts about defined benefit plans:

• DB plans require complicated actuarial valuations and funding calculations that DC plans do not need;
• DB plans are subject to Pension Benefit Guarantee Corporation (PBGC) premiums, as well as burdensome notice and spousal consent requirements on benefit distributions. The cost of PBGC premiums is something that a DC plan does not have to pay;
• A DB plan requires mandatory employer contributions to make the required funding level. If those mandatory payments are not made, then the employer gets hit with interest + penalty payments under IRC § 4971.

December 22, 2009 10:55 AM

Bill Black said...

Part Three of Four:

In follow-up to the issue of this company’s “$250,000” deferral plan, I took a moment to do a quick web search for typical actuarial fees for a small defined benefit plan. I came across this website: http://www.pensionsite.org/DefBenefitPlans.html. If you click on that link, scroll down to the bottom. It shows that this firm’s basic annual pension administration fee for a DB plan is $2,250 + $50 per participant.
As you know, our pension recordkeeping fee for our 401(k) clients is $800 + $45 per employee. I assume that the majority of the difference between our recordkeeping fees vs. the DB fees listed above is attributable to the actuarial fees. Hence, using the rough estimate of the annual actuarial fees for a small DB plan, it will cost the client $1,450 more per year ($2,250 - $800) when they use a smaller competitor. Mostly – it’s more confusing, more expensive and more work. I hope our competitor is disclosing the additional actuarial fees to their prospects if they go this route because there is about a 1% chance this will benefit the client.

Again, it appears the author misses the point, the concept and the benefits of the tax deduction.

Consider this:
DB deduction (from above): $268,394
Maximum DB (401(k) with catch-up) 54,000
Difference, or DB advantage: $213,894
Annual tax savings (assume 42% combined state and federal tax bracket): $ 89,835

According to the blog’s author, DB fees are $1,450 more than Guidant’s DC fees, but the clients’ tax savings are almost $90,000 more for the additional $1,450. Never will a businessperson complain about a cost-benefit ratio like that! And by the way, a PBGC premium is about $33 per participant.

Assume the typical DB plan deduction of $125,000. How does the fee compare? (Keep in mind a DB plan is truly budget driven. A client states his contribution ability, we design a plan to achieve that deposit goal.)

DB Plan: $125,000
Less DC Plan (401(k) + catch-up): 54,500
Difference: $ 79,500
Tax Savings at 42%: $ 29,610

Again, a cost-benefit ratio that stands on its own merits.

As for the statement “I hope our competitor is disclosing the additional actuarial fees to their prospects if they go this route because there is about a 1% chance this will benefit the client.” Disclosure is much more thorough than the author assumes. Let’s face it, the client is being asked to make a six-figure decision. It is paramount the client’s CPA is brought into the decision making process. For that matter, the client may want the attorney involved, too. All facts and nuances are disclosed. Not to mention, fees are clearly disclosed on the web site where the blog’s author readily found it.

December 22, 2009 10:56 AM

Bill Black said...

Part four of four:

In summary, a DB plan is not “voodoo or “fuzzy” math. It is actuarial science. The deposits, while larger than those in DC plans, are valid nonetheless. Think about it this way: if these larger contributions were not valid, how could one entice an Enrolled Actuary and a client’s CPA to collude and deduct something on a tax return that is against the letter and spirit of the law?

If it is not valid, why would Internal Revenue continue to accept Form 5500, with attached Schedule SB, certifying the large deposit?

In closing, the above hopefully clears any confusion on the difference in DB and DC plans and the author’s mistaken concept of how DB deposits are constructed. While a DB’s appeal and benefit are not for every client, they fit well in the right circumstance.

Thank you again for providing a link to our web site.

Bill@PensionSite.Org

December 22, 2009 10:56 AM

Guidant Financial Group said...

These are great comments! Thank you for putting so much time into the response. The terms “fuzzy math” and “common sense” was directed at the ambiguous marketing language used by other companies. Guidant agrees with you that there is a place for DB pension plans – but it is not generally with our demographic. Contrary to what others may say (and your comments confirm) DB pension plans are not right for everyone. While the tax deductions from a DB can be significant, our clients are buying individual franchises and small businesses. The majority cannot defer $46,000 – let alone $250,000. If the business cannot take advantage of the benefits of a DB – then cost (which you are right is relative) is a detractor.

As a basic reminder, the Guidant 401(k) allows and individual to invest their retirement funds into a business or franchise without taking a taxable distribution or receiving a loan. You specifically reference medical and financial professionals like Doctors and CPA’s. Professional corporations (the legal entity that a Doctor or CPA would use) generally require that all shareholders be licensed. Because the plan is a shareholder – we cannot structure professional corporations. Since our typical client excludes medical, legal and tax professionals - there are very few instances where our clients can take full advantage of a DB plan.

In summary, we are in full agreement. It appears that your site was listed because we felt it provided credible information and would be a great resource for those investigating a DB. Thanks again for the contribution!

December 28, 2009 1:51 PM