1. Financial Fiduciaries, LLC
WAMIC Directors seminar

2. Financial Implications of Defined Benefit Plans and Other Alternatives
Presented By:
Thomas W Batterman
Fiduciary Advisor
Financial Fiduciaries, LLC
November 9/16, 2016

3. Contrasting Defined Benefit with Defined Contribution Plans
Focus is on what is contributed
The amount “is what it is” at employee’s retirement, and determines retirement benefit
Defined Benefit
Focus is on providing a certain monthly distribution for the employee at retirement
E.g., equal to of 5 highest years of comp
The amount of the contribution needs to be sufficient to fund the expected distribution

4. Reverse of a Mortgage Calculation
Mortgage Example $100,000 Mortgage Amount 5% interest 15 year amortization Principal & Interest monthly payment $790.79

5. Defined Benefit Calculation
Start with the designated benefit amount
$790.79
How much money is needed to fund this benefit?
It is a function of how long the benefit is going to be paid and what you are going to earn on the funds pending payout.

6. Variable Inputs Length of benefit payment
Determined by life expectancy
Single or joint life affects the calculation
Fund Earnings
How much are your investments going to earn?

7. Example
If the plan needs to provide a monthly benefit of $790.79, the applicable life expectancy is 15 years and the assumed earnings rate is 5%, how much money does the plan need to have put away to fund this benefit?
$100,000

8. Different Life Expectancy
Assume the same benefit level and the same earnings rate, but different life expectancy
20 year life expectancy
$119,825
10 year life expectancy
$74,557

9. Different Earnings Rate
Assume the same benefit level and same life expectancy (15 years) but different earnings rate
3% earnings rate
$114,511
8% earnings rate
$82,749

10. Different Payment Requirement
What happens if the payment increases?
Why would this happen?
Increased salary increases pension amount
Assume 15 year payout and 5% interest, but payment increases to $850
Required funding = $107,487

11. One Added Complication
The required funding is the amount necessary to fund the benefit at normal retirement
E.g., at age 65
Question:
How much must you contribute today for a 45 year old employee in order to have the required funding in the plan when that employee attains age 65?

12. Present Value Calculation
If the plan requires $100,000 when the employee reaches age 65 (in 20 years) and the plan assumes an investment return of 5%, how much do you need to deposit today in order to have that deposit grow to $100,000 in 20 years?
$37,689

13. Effect of Employee Age $82,270
What if the plan just started (so there are no accumulated funds in the account) and a 61 year old employee needs $100,000 in the plan at age 65 to fund the projected benefit?
$82,270
As this amount far exceeds what could be contributed to a DC plan, this is a planning tool for small employers looking for big tax deductions

14. Impact on Financial Statements
High administrative costs
Difference between accumulated fund and what is required to be in the fund is your required annual contribution
Liability at year-end
Reduces surplus
Personnel expense on income statement

15. Company Guarantees Fund Balance
The Company is essentially guaranteeing that the required fund balance will be in the plan
What affects contribution requirements?
Negatively (increases required contribution)
Investment returns less than assumed rate (5% here)
Retired employees outliving their projected payout
New payroll (new employees or higher wages)
Positively (decreases required contribution)
Investment returns exceeding assumed rate (5% here)
Retired employees dying early
Reduced payroll

16. Other Types of Retirement Plans
Defined Contribution Plans
Focus is on calculating the amount to be contributed, not the amount to be received by the employee
Types
SEP
SIMPLE
401(k)

17. Simplified Employee Pension (SEP)
Company makes a contribution to each eligible employee’s IRA set up for this purpose
Amount is completely discretionary with the Company and determined annually
Broad eligibility – as little as $550 in comp
May tighten up by adding 3 out of last 5 years
Percentage of contribution in relation to compensation must be the same for all

18. $10,000 Company Contribution
Sample SEP Allocation
$10,000 Company Contribution
Salary
Contribution
Cont/Salary %
$50,000
$5,000
10%
$30,000
$3,000
$20,000
$2,000

19. SEP Summary Benefits Contribution amount is flexible
No administrative costs
Detriments
Broad coverage requires contributions for more employees than a standard retirement plan
All contributions are 100% vested
Employees may withdraw funds prior to retirement if willing to pay taxes and penalties
No facility for employee voluntary saving

20. SIMPLE Employee establishes an IRA Broad eligibility
$5,000 or more of comp in 1 or 2 of last 5 years
2 types of contributions
Employee deferrals
Employees direct funds they would otherwise receive as wages into the plan as deferrals
Employer contributions are required
Alternative formulas:
2% of employee compensation regardless of deferral, or
100% of what employee defers up to 3% of compensation

21. SIMPLE Employer Matching Example
100% up to 3%
Compensation
Deferral
Match
$40,000
$1,000
$1,200
$2,000

22. SIMPLE Summary Benefits No administrative costs
Allows employees to save for retirement
Detriments
Broad coverage requirements
All Company contributions 100% vested
No facility for additional Company contributions
Employees may withdraw funds prior to retirement if willing to pay taxes and penalties

23. 401(k) Plans Employees can defer salary like SIMPLE
Employees can direct their own investments like both SIMPLE and SEP
No required Company contributions. Except:
Safe Harbor election would lock Company into annually renewable SIMPLE-like contributions
ADP, ACP & Top Heavy contributions may be required
Company may contribute a percentage of salary like a SEP, match a certain amount of the employee’s contribution like a SIMPLE, or both.
Company contributions (except from 3 above) may be subject to a vesting schedule

24. 401(k) Summary Benefits Flexible funding alternatives for the Company
Both employee and Company contributions are possible in the same plan
Vesting helps ensure employee longevity
In-service withdrawals can be denied
Coverage may be limited to full-time staff
Detriments
Administrative costs
- Hard charge or imbedded in investment costs
Annual governmental reporting and other requirements

25. Non-Qualified Plans Qualified Plans generally:
Have rules that require equal treatment for all employees
Have assets segregated from the Company’s funds in a separate account for the employee
Non-Qualified Plans
Can be set up for a single employee or a small group of employees
Not subject to rules of qualified plans
Assets normally can’t be segregated from Company funds to avoid employee paying current income tax on the benefits

26. Non-Qualified Plans (cont’d)
Can involve Company contributions, Employee contributions or both.
No current tax deduction for the Company for contributions it or the employee makes
Tax deduction is taken in the future at distribution
Administrative complexities
Written plan document required
Governmental notice required
Trust administration necessary if Rabbi Trust

27. Procedures to Change Plan Form
Defined Benefit Plan
Plan funding requirement must be fully funded
Plan is terminated and accumulated benefits are paid out to the employees
SEP
Company stops making contributions
Employees end up with an IRA
SIMPLE
Company announces the plan is ending
Future contribution obligations terminate

28. Changing Form (cont’d)
401(k)
Employer gives notice of plan termination
Plan must be brought up-to-date with all required plan amendments before terminating ($$)
Notice of termination provided to employees
All non-vested Company contributions become 100% vested
Upon termination, balances are distributed to employees to take in cash or rollover to their IRA

29. Financial Fiduciaries
Questions?
Thomas W Batterman
Financial Fiduciaries
(800)