Establishing a defined-benefit plan to maximize contributions for older shareholder-employees.A defined-benefit (DB) pension plan is designed to provide a definitely determinable Liable to come to an end upon the happening of a certain contingency. Susceptible of being determined, found out, definitely decided upon, or settled. determinable adj. annual retirement benefit in the form of a pension. The benefit is calculated using the plan s benefit formula and must be funded during the employee's working years. The computation of the annual contribution needed to provide this benefit requires complex actuarial ac·tu·ar·y n. pl. ac·tu·ar·ies A statistician who computes insurance risks and premiums. [Latin calculations. This annual contribution becomes a fixed obligation, funded without regard to the employer's financial condition. Ideal Scenario Establishing a DB plan is most advantageous for a corporation with stable or growing earnings and shareholder-employees age 50 and older with long service records. The corporation should have the financial resources to meet the DB plan's funding requirements for at least five (preferably, 10) years, to avoid IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. arguments that the plan was not intended to be permanent when adopted. Advantages The advantages of a DB plan are: 1. The employer generates current tax savings, while accumulating retirement benefits primarily for the owners. 2. Shareholder-employees avoid current taxation on the benefits being funded for them. 3. Shareholder-employees' account balances will increase dramatically over a relatively short period, due to large employer contributions and tax-deferred earnings thereon there·on adv. 1. On or upon this, that, or it. 2. Archaic Following that immediately; thereupon. Adv. 1. thereon - on that; "text and commentary thereon" on it, on that . Disadvantages There are some significant disadvantages to DB plans. The administrative costs administrative costs, n.pl the overhead expenses incurred in the operation of a dental benefits program, excluding costs of dental services provided. can be significantly higher than those for other plan types, due to the requirement to obtain actuarial services annually. Also, the employer will bear the burden of any investment losses, in the form of increased funding requirements. Because a DB plan guarantees a certain benefit, investment losses will require larger contributions to maintain those benefits. Of course, investment gains will reduce the employer's funding requirements. Example David, Mark and John own Boxcorp, a calendar-year C corporation. Over the past five years, sales have doubled and net profits have tripled. The owners want to maximize their accumulation of retirement dollars and the corporation's deductions, because Boxcorp is in the 34% bracket In programming, brackets (the [ and ] characters) are used to enclose numbers and subscripts. For example, in the C statement int menustart [4] = ; the [4] indicates the number of elements in the array, and the contents are enclosed in curly braces. . The following summarizes pertinent information for the three shareholder-employees:
Mark John
Age 55 56 55
Past service (years) 8 9 10
Compensation $225,000 $225,000 $225,000
In addition to the three shareholder-employees, Boxcorp has 30 rank-and-file employees whose compensation ranges from $23,000-$35,000. These employees have been with the company for nine or 10 years. Information for five of these employees is illustrated in the exhibit at right. Each employee represents six other individuals with identical characteristics. Boxcorp will continue to be profitable and have no problem funding any retirement plan chosen. Planning: Because funding is not an issue, Boxcorp should select a plan that allows it to make large contributions (resulting in larger tax deductions Tax deduction An expense that a taxpayer is allowed to deduct from taxable income. tax deduction See deduction. and higher retirement benefits for the shareholder-employees). Because the corporation has a relatively short period in which to fund the shareholderemployees' retirement accounts (all three shareholder-employees are in their 50s), a DB plan is probably the best option. However, Boxcorp will be obligated ob·li·gate tr.v. ob·li·gat·ed, ob·li·gat·ing, ob·li·gates 1. To bind, compel, or constrain by a social, legal, or moral tie. See Synonyms at force. 2. To cause to be grateful or indebted; oblige. to fund DB contributions annually--i.e., it cannot make a contribution in one year and skip the next. Editor's note Editor's Note (foaled in 1993 in Kentucky) is an American thoroughbred Stallion racehorse. He was sired by 1992 U.S. Champion 2 YO Colt Forty Niner, who in turn was a son of Champion sire Mr. Prospector and out of the mare, Beware Of The Cat. Trained by D. : This case study has been adapted from PPC's Tax Planning Tax planning Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer. Guide--Closely Held Corporations, 17th Edition, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Siegel, Richard L. Burris, James A. Keller, Gary W. Brown, James Brown, James, 1933–2006, African-American rhythm-and-blues singer known as the "godfather of soul," b. Barnwell, S.C., as James Joe Brown, Jr. Abandoned by his parents, he left school in the seventh grade and turned to petty crime. J. Mogelnicki and William R. Bischoff, published by Practitioners Publishing Company, Fort Worth, TX, 2004 ((800) 323-8724; www.ppcnet.com). Albert B. Ellentuck, Esq. Of Counsel . King & Nordlinger, L.L.P. Arlington, VA
Exhibit: Boxcorp employee information
A B C D E
Age 30 32 32 34 35
Past service 9 9 10 10 10
(years)
Compensation $23,000 $25,000 $25,000 $30,000 $35,000
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