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Welcome to our November 1 Issue of Danziger Pension Intelligence.  Topics in this issue include:

4th Quarter Planning to Maximize Contributions for Owners.  This is a time-sensitive topic because many actions must be taken before the end of this year.

2017 Retirement Limits.  Some increases represent a tax increase, but others provide valuable new opportunities for owners.  The article contains a chart of new limits and illustrations demonstrating impacts.

• Welcome New Staff.  We have hired some great new team members, one of them, Ken Schneider, is known to many in the retirement plan industry.


It’s the 4th Quarter:  Time is Running Out to Maximize Contributions for Owners & Highly Compensated Employees This Year

In this article we focus on year-end action items to maximize contributions for Owners and other Highly Compensated Employees (HCEs) this year.  Many opportunities are still available, but only if they are implemented before the end of this year.  Our next article will focus on actions that must taken before the end of this year in order to be available next year.

Planning for This Plan Year
I met with the owner of a small business recently.  Profits are up and so are her taxes.  All combined she is paying over 35 percent in income taxes. Her accountant projects she will have a profit of $100,000 beyond living expenses and owe $35,000 of income tax.  How, she asks, can she invest the $35,000 for the long term instead of paying it off as taxes now.  She sponsors a 401(k) Profit Sharing Plan but it does not provide the benefits she expected.  She spends a lot on contributions for Non-Highly Compensated Employees (NHCEs) and HCEs must take taxable refunds.  What can be done to improve results?  Fortunately, we were meeting before year-end.  There are still opportunities for valuable changes. Here are some examples:

Optimizing 401(k) Contribution:
• We amended the plan’s testing method from Prior Year to Current Year. This allows client to use current year NHCE contribution rates in the ADP Test which governs the maximum rate of deferrals by HCEs. It is advantageous because NHCEs have started saving at a higher rate. It allows HCEs to increase their average rate of deferrals from four percent to five percent of pay. It was enough to avoid refunds this year.

• We considered making Qualified Non-Elective Contributions (QNECs). These are company paid 401(k) contributions that are counted in the ADP Test.  By targeting QNECs to low-paid NHCEs, we are able to increase the maximum rate for HCEs from five percent to six percent, at a fairly low cost to the company. (This stategy would not have been available if the Plan were still using Prior Year testing.)

• We encouraged HCEs to use the higher limits from above more effectively, by ‘shifting’ deferral rates among themselves. For example:

Assume there are two HCEs; Owner and Spouse. The maximum average rate of deferrals is six percent of pay. Spouse earns $50,000 and defers $5,000 (i.e., ten percent of pay). The owner earnes $150,000, but can only defer $3,000 (i.e., two percent) because that brings the HCE average to the maximum six percent. Total family savings for the year is $8,000.

By following our suggestion, the owner now defers the maximum, $18,000 (i.e., twelve percent of pay) and the spouse defers nothing. The average remains at six percent, but the family’s savings have risen from $8,000 to $18,000.

Note: Even better results are possible if owner’s child participates. For example – Assuming the maximum average rate for HCEs remains at six percent the child defers nothing, the owner defers $18,000 (twelve percent) and the spouse defer $3,000 (six percent). Their average rate is six percent, but the couple’s savings increased to $21,000. Better yet, because the child is not an “Active Participant” with high compensation, he can defer $5,500 into a Roth IRA.

• We make sure HCEs are actually using the maximum limit by checking their year-to-date deferrals and suggesting an increase in withholding or a year-end bonus from which the maximum amount can be withheld.

Consider Making a Safe Harbor, Profit Sharing and/or Matching Contributions:
• Now is the time to consider whether to exercise a Safe Harbor Option.  It would allow HCEs to maximize contributions this year regardless of NHCE deferral rate.  Options are more flexible because they need not be exercised until the end of the year, when a company’s profitability is better known.  The challenge is that the option must be reserved before the beginning of a year.  In this case, it was not reserved last year, and therefore, is not available this year. (See our article on planning for the next plan year suggesting it be implemented now for next year.)

• You need not commit to make Profit Sharing and Matching contributions until the tax return due date for the current year.  However, advance action may be necessary to amend the plan’s contribution formula.  This must be completed  before year end. (Note that IRS posits conditions that may prevent end-of-year formula changes.  These should be considered before amending.)

• Advance planning for contributions is also valuable to determine whether a contribution is financially advantageous under current demographic conditions.  If so, one can budget for cash flow and estimated tax payments.  A projection will also help management consider whether to count an employee’s contribution in determining year end bonuses or pay raises.

• Profit sharing is often thought of as costly for employees. However, the cost of profit sharing may be significantly less than a Safe Harbor or QNEC.  This is most true with profit sharing formulas that put each participant in a separate contribution category.   Here is a rough example using the business descibed above:

Assume a company has three HCEs (Owner, Spouse and Child) and three NHCEs.  Under the right circumstances, the company can declare a contribution of more than $50,000 for the owner while having to give as little as five percent of pay to just one of the NHCE’s.

The best way to determine whether profit sharing give a large share of contribution to owners is to run an illustration measuring the benefit for owner against the cost for NHCEs.  If the cost for employees is a small portion; e.g., 10% of the total contribution, it may be financially better to benefit your employees than paying away 35% of the contribution to taxes.

Consider Adopting a New Proft Sharing or Cash Balance Pension Plan:

There is still time to adopt a new plan retroactive to the beginning of the current year. It might be a Profit Sharing plan if IRS’s rule says the current formula cannot be amended.  It also could be a Cash Blance Pension Plan that allows for annual benefits of $200,000 or more.  Caution must be exercised before adopting Cash Balance Pension Plans because they are subject to mandatory contribution requirements.  However, if the fit is good, the opportunity to adopt is still available until the last day of the year.

Pro-Active Consulting is the Key to Optimizing Contributions for Highly Compensated Employees

It won’t matter that a client has the most sophisticated plan design allowed by law if you don’t utilize it to the company’s advantage.  Too often, a strategy that worked well last year can be destructive this year due to changes in demographic or business conditions.  Once a beneficial opportunity is identified, it must often be implemented  before the end of the year. That is why the 4th Quarter is the time for action.

We welcome your inquiries and offer a complimentary intitial consultation to see if plan desings are flexible and action is being taken promptly to optimize results for owners and other valued employees. Please contact me at 215-322-4202 or David@DanzigerPlans.com.

David Danziger, JD, LLM

Law Offices of R. David Danziger, P.C.

NOTICE:  This article is intended to provide general information on matters of interest in the area of Qualified Retirement Plans.  It does not serve as legal advice and should not be relied on as applicable to any particular fact or circumstance.  You should not act without first seeking the advice of an experience advisors.

© Law Offices of R. David Danziger, P.C., 2016.  All rights reserved.


2017 Retirement Plan Limit Changes & Consequences 

Item Limit 2016 2017 Change
1 Maximum 401(k) Deferral $18,000 $18,000 $0
2 Maximum Catch-up $6,000 (for those born in 1966 or earlier) $6,000 (for those born in 1967 or earlier) $0
3 Maximum Defined Contribution Allocation (415 Limit) $53,000 $54,000 $1,000
4 Maximum Compensation for Contribution Testing $265,000 $270,000 $5,000
5 Prior Year Compensation for Highly Compensated Employee Status $120,000 $120,000 $0
6 Social Security Taxable Wage Base $118,500 $127,450 $8,950
7 Maximum Cash Balance Plan Lump
Sum Benefit (Estimated)
$2,600.000 $2,700.000 $100,000


Impact of New Limits

1.  Social Security Taxable Wage Base Increase:
Compensation up to the Taxable Wage Base (row 6 above) is subject to a Social Security payroll tax for Old Age Security and Disability Insurance (OASDI).  The rate is 6.2% payable by employees, and 6.2% payable by employers; making a total rate of 11.4%.  Beginning in 2017, income up to $127,450 will be subject to this tax. This is an increase of $8,950.
This results in a tax increase of $1,020. (i.e., $8,950 times 11.4%) for those earning $127,450 or more.
NOTE:  Employer paid retirement plan contributions are exempt from Social Security taxes.  Therefore, if you were to cap your salary at $118,500 and contribute $8,950 as profit sharing, $1,020  of it would be paid by savings on Social Security Tax.  This is in addition to the benefit of income tax deferral.

2. Higher Maximum Compensation Limit:
The maximum Compensations limit has increased by $5,000 (see row 4 above).  This creates opportunities in at least two respects:

a. Higher Contribution Amount – At Same Rate of Compensation:
Let’s assume a plan makes a 10% profit sharing contribution and the owner earns $270,000 in both 2016 and 2017.  In 2016, we cannot count $5,000 of his compensation because it exceeds the maximum limit.  For example:

Compensation
2016 2017
Eligible Compensation $265,000 $270,000
10% Profit Sharing $26,500 $27,000
Increased Contribution $500

The owner’s contribution has increased by $500 without having to increase the rate of contribution for non-owners.

b. Easier to Pass the ADP Test on 401(k) Contributions:
Maximum contribution limits (rows 1 & 2 above) have not changed.  However, maximum compensation has increased by $5,000.  As a result, it will be slightly easier to pass the Average Benefit Deferral percentage test for high earners, because the numerator has increased.  That is:

Highly Compensated Employee Non-Highly Compensated
2016 2017 2016 2017
Deferral Amount $18,000 $18,000 $3,500 $3,500
Compensation $265,000 $270,000 $75,000 $75,000
Deferral Rate 6.79% 6.67% 2.67% 2.67
Maximum Rate 4.67% 4.67%
Refund $90 $0

The change is not significant in 2017.  However, it is a free increase.  And, when combined with other techniques to increase maximum deferral rates, Highly Compensated Employees can enjoy significant increase in 401(k) contributions without having to contribute additional amounts for Non-Highly Compensated Employees.  Contact us for additional planning opportunities.

3. Higher Maximum Contribution:
The maximum annual Defined Contribution Plan (e.g., 401(k) Profit Sharing Plan) limit has increased by $1,000. (See row 3 in the table above.)  Individuals can now shelter $54,000 per year (plus catch-up), compared to $53,000 (plus catch-up) in 2016.  Here is some analysis:

a. More Dollars Without Increase in Contribution Rates:
In the discussion regarding higher maximum Compensation levels, we identified opportunities to increase savings by $590 per year, at no additional cost for employees.  If the Maximum Contribution remained at $53,000, the only benefit of the $590 would be the opportunity to reduce contribution rates for Non-Highly Compensated Employees by a little more than 0.2% of their compensation.  However, with the higher maximum contribution, the owner can add the $590; bringing his contribution to $53,590 without increase in staff contribution rate.

b. $1,000 Increase for Owner in Return for as little as 0.0123% Increase in Contributions for Staff:
Owners will, in many cases, obtain the extra $1,000 contribution through an increased Profit Sharing contribution.  As a percent of $270,000 compensation, it represents 0.123% of pay.  Under so-called Minimum Gateway Contribution Rules, Non-Highly Compensated Employees must receive a contribution of as little as one-third of that rate; a mere 0.037% of pay.  So, for example, the owner could get $1,000 in return for a $123 contribution for Non-Highly Compensated Employees.  That is:

i. Rate of Contribution for Highly Compensated Employee:

$1,000 divided by $270,000 equals 0.37% of Pay

ii. Gateway Rate for Non-Highly Compensated Employees:
0.37% divided by 3 equals 0.123% of Pay

iii. Dollar Cost for Non-Highly Compensated Employees (assuming $100,000 eligible compensation):
 $100,000 times 0.123% equals $123

iv. Analysis: Owner gets 89% of the additional profit sharing contribution
i.e., $1,000 divided by $1,123 equals 89%

4. Higher Maximum Lump Sum Cash Balance Pension Plan Value:
The maximum annual life-annuity benefit under Defined Benefit plans has risen from $210,000 to $215,000, beginning at age 62.  This translates into an estimated increase of $100,000 in maximum lump sum accumulation.  Annual contributions can increase to reach this higher goal.  Note that a plan amendment may be needed to increase benefits.  (The new maximum compensation limit discussed in 2 above will help to hold down any increase in contributions for Non-Highly Compensated Employees.)


Welcome New Staff

ken-schneider-11-7-16

Ken Schneider has joined us as a Senior Plan Consultant.  He has been practicing in this field for over twenty years.  Clients and advisors love working with Ken as he is personable and very effective.  Prior to joining us, Ken was with the MandMarblestone Group (formerly Mand Marblestone & Danziger).  He is looking forward to working with you.

phyllis-ituriaga-11-7-16

Phyllis Ituriaga (pronounced “Turiaga”) has taken over for Renee Peters as our Client Service Representative. She answers our phones and will help you get what you need promptly and with personal attention.  Prior to joining our team, Phyl was highly instrumental in operating a Manhatten law firm.


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