1. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning for Retirement Needs Plan Funding and Investing— Part I Chapter 11

2. Copyright © 2007, The American College. All rights reserved. Used with permission. Overview Plan funding Funding vehicles Legislative environment

3. Copyright © 2007, The American College. All rights reserved. Used with permission. Defined-Benefit Minimum Funding Standards Two items to fund: Normal cost Past service liability A variety of funding methods exist The funding method does not determine the ultimate plan cost Actuaries use many assumptions (see text) A fully insured plan is exempt from the funding standards (Section 412(i) plans)

4. Copyright © 2007, The American College. All rights reserved. Used with permission. Funding Requirements Employer’s must: –Set aside funds irrevocably –Place the funds with a trustee –Fund pensions in advance (a terminal funding (pay as you go) approach is not allowed)

5. Copyright © 2007, The American College. All rights reserved. Used with permission. Maximum Deductible Contribution Small employers are looking to maximize tax shelter (want to make excessive deductible contributions) The DB benefit limit is $180,000 (2007) The maximum DB contribution is based on the higher of two calculations and can be much larger than the $45,000 (2007) DC contribution limit

6. Copyright © 2007, The American College. All rights reserved. Used with permission. Maximum Contributions for Small Business Owners See Table 11-1

7. Copyright © 2007, The American College. All rights reserved. Used with permission. Funding Other Plans All pension plans subject to minimum funding (10 percent excise tax for failure to meet minimum funding standards) Maximum contribution limits –25 percent for all defined-contribution plans (aggregated) –There is an exception for 401(k) salary deferrals –Code Sec. 415(c) limit ($45,000 in 2007) –There is an exception for catch-up elections –See text

8. Copyright © 2007, The American College. All rights reserved. Used with permission. Funding Vehicles Trusts Grantor = plan sponsor Res (property) = plan assets Trustee = run the trust Beneficiary = participants Common trust funds An exception to the general rule of comingling funds that is used for small plans Split-funded Both trust and insurance company Annuity contracts

9. Copyright © 2007, The American College. All rights reserved. Used with permission. Trust Document specifies –Irrevocable trust –Investment powers of trustees –Allocation of fiduciary responsibility –Payment of benefits –Rights upon plan termination –Change in trustees –Accounting

10. Copyright © 2007, The American College. All rights reserved. Used with permission. Who is considered a Fiduciary? Anyone with discretionary authority over purchase or sale of securities Anyone who renders investment advice on a regular basis Doesn’t always include those who sell investment products Anyone who has discretionary control over plan administration

11. Copyright © 2007, The American College. All rights reserved. Used with permission. Examples of Fiduciaries Sponsoring company Plan trustees Investment managers Insurance companies Officers who select trustees Insurance agents and brokers (if they control investment of assets)

12. Copyright © 2007, The American College. All rights reserved. Used with permission. Examples of Involved Parties Who Are Not Considered Fiduciaries Accountants Lawyers Administrative firms An insurance agent or broker who is simply a service provider and has no control over plan assets –No fiduciary liability if acting on specific buy/sell instructions

13. Copyright © 2007, The American College. All rights reserved. Used with permission. Your Financial Services Practice When you are working with plan assets, what is typically your role? (selling investments to fiduciaries or investment advisor making discretionary decisions) If selling investments, what steps do you take to ensure that you do not inadvertently become a fiduciary? What services do you or your company provide that help the plan fiduciaries meet their fiduciary obligations?

14. Copyright © 2007, The American College. All rights reserved. Used with permission. Affirmative Duties For Fiduciaries Exclusive benefit- discharge duties solely in the interest of plan participants and beneficiaries Provide benefits and defray reasonable expenses Prudence -Person acting in like capacity and familiar with such matters would have acted in a similar manner

15. Copyright © 2007, The American College. All rights reserved. Used with permission. Determining Prudence What is the role of investment looking at the total portfolio? Have you considered diversification of the overall portfolio? Is the potential return commensurate with the risk involved? Have you considered the cash flow needs of the plan? Is the potential return appropriate given the funding objectives of the plan?

16. Copyright © 2007, The American College. All rights reserved. Used with permission. Affirmative Duties Diversification Minimize the risk of large losses Diversify among asset classes Diversify within a single asset class Conform with documents Read the trust for investment restrictions

17. Copyright © 2007, The American College. All rights reserved. Used with permission. 404(c) Individual Account Exception Fiduciaries are not liable for participant investment decisions as long as: At least three diversified investment options An employer stock option in addition to the three options Diversification-pass through investments (e.g., mutual funds) Self directed funds- participants must be able to change options at least quarterly (exercise reasonable control) The plan must provide risk and return information Participants entitled to additional information upon request Fiduciaries are responsible to make prudent decisions concerning the available options

18. Copyright © 2007, The American College. All rights reserved. Used with permission. What is a Prohibited Transaction? Sale, exchange, or leasing of property between plan and party in interest Lending of money between... Furnishing goods or services... Transfer to or use by party in interest Acquisition of employer securities that are not qualified or more than 10 percent

19. Copyright © 2007, The American College. All rights reserved. Used with permission. No Self Dealing Fiduciaries can not use the plan’s assets for own self interest

20. Copyright © 2007, The American College. All rights reserved. Used with permission. Who is a Party in Interest? Fiduciaries/administrators/trustees Plan counsel/service providers Employer Employee organization Employees, officers, directors and 10-percent owners

21. Copyright © 2007, The American College. All rights reserved. Used with permission. Is this a Prohibited Transaction? A loan to a participant or a loan to the owner? Plan purchases valuable art and the owner displays in his home? A plan buys property and leases it to the company? Plan pays a pension lawyer for his services?

22. Copyright © 2007, The American College. All rights reserved. Used with permission. Exemptions Statutory (see text for list page 257) Administrative Individual (PTE) Examples Loans Fiduciary gets reasonable compensation for services rendered An action that can be shown to benefit employees

23. Copyright © 2007, The American College. All rights reserved. Used with permission. Fiduciary Liability Personally liable for losses & profits Liable for breaches of co-fiduciaries Knowing participation or concealment Knowledge and failing to stop other fiduciary

24. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions In a money-purchase plan, the employer must contribute the amount required under the plan’s contribution formula each year. The minimum funding requirements stipulate that plan assets must equal or exceed the cost of providing all promised benefits at any point in time. In a defined-benefit plan, if the actuary chooses a lower mortality assumption (the rate at which active employees and retired employees will die), the required contribution will be reduced.

25. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions In a defined-benefit plan, if the actuary selects a higher estimated rate of investment return, the annual cost will be increased. A loan from the plan to the plan administrator is not a prohibited transaction. A plan trustee can make an investment that benefits the trustee, as long as the investment is good for the plan.