Guest Contributor, David T. Mayes, MA, EA, CFP®
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Starting in January 2010, practice owners who currently sponsor a retirement plan for themselves and their employees will have a new option to consider as an alternative to the ubiquitous 401(k). Commonly referred to as 414(x) or DB-K plans, this new option adds a defined benefit (pension) component to the more familiar 401(k). But, by combining the two, the administrative burden of operating separate plans is eliminated. These combined or hybrid plans were originally created under the Pension Protection Act of 2006, but were not slated to become effective until 2010.
If, as a practice owner, you would like to minimize your current taxes by setting aside as much as possible for retirement as well as attract and retain talented employees by offering valuable, significant retirement benefits, a DB-K plan may be a good alternative. Because of their defined benefit component, these plans allow for larger retirement plan contributions than 401(k) plans, helping to solve a couple of issues: 1) The practice owner’s need to maximize retirement plan contributions and 2) the employee’s desire for an additional source of guaranteed income to supplement social security.
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In addition to simplifying administration by eliminating the need for separate 401(k) and pension plans, eligible combined plans are not subject to the administratively costly nondiscrimination or top-heavy testing imposed on the standard 401(k). This is because the 401(k) piece of the combined plan requires specific limits for employee salary deferrals and employer matching contributions. The DB-K plan requires automatic employee contributions equal to four percent of compensation, with the employer providing a 50% matching contribution. Employees may elect not to participate in the plan, or to have contributions made at a different rate.
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The defined benefit portion of the plan provides for an annual retirement benefit equal to a percentage of the participant’s final average pay. The applicable percentage is determined by crediting each employee with 1 percent for each year of service, up to a maximum of 20%. Final average pay is defined as the period of consecutive years, up to a maximum of five, during which the participant had the greatest aggregate compensation. Because this formula requires larger contributions to the plan on behalf of older, higher-earning employees, the hybrid plan naturally generates substantial contributions for the benefit of the practice owners.
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David T. Mayes, MA, EA, CFP® is a financial planner at Mackensen & Company, Inc., a fee-only financial planning firm in Hampton, NH. He is also a member of the National Association of Personal Financial Advisors (NAPFA) and the MD Preferred Financial Advisor Network. He can be reached at 603-926-1775 or david.mayes@mackensen.com.
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