Featured Articles |
RCG Extras |
Join Our Mailing List |
New Benefit Plan Designed to End Partner Worry Over Comfortable RetirementA newly developed retirement benefit plan now offers Professional Service Firms and their highly compensated partners a clearer path to comfortable retirement. The Professional Roth PlanSM delivers a tax-advantaged investment vehicle for participating partners without impact to firm’s financial condition. What’s more, plan assets are safe from firm’s creditors in case of bankruptcy.
If you are fortunate, once in a while you can create something truly different. It doesn’t happen often. As retirement benefit consultants, we have worked alongside Fortune 500 teams, partnerships, and other pass-through organizations for many decades in review of many so-called unique retirement programs. For more than thirty years, our principals have designed company-sponsored deferred compensation arrangements for a wide range of plan holders and participants. What we are about to share is distinctive; we even purchased the plan for ourselves.
Tipping Point In the last six months, executive compensation has been placed front and center in the media spotlight by the now infamous corporate scandals that followed the dotcom flame out and market meltdown, which began in April of 2000. In response to recent regulatory changes, we co-authored a white paper with Dr. Arthur B. Laffer, the father of supply side economics and economic advisor to President Reagan, entitled, “The Five Most Dangerous Trends in Nonqualified Deferred Compensation Post 409A.” The central theme explored the issues facing participants regarding wealth accumulation following new, more restrictive regulations on retirement plans, and the need for organizations to use these plans to attract, retain and reward their key people. The new legislation placed many restrictions on traditional deferred compensation arrangements. In the ten months invested in research and analysis on the article, we became intent on filling this retirement gap by offsetting the restrictions with differently designed plans.
Minimizing a Dilemma For more than 20 years, corporate America implemented nonqualified deferred compensation plans. These plans have been designed to be “unsecured promises” because the assets held are subject to employer’s creditors. As account balances grow, executives are naturally concerned over any “unsecured” promise. But with new legislation, many plans lost the flexibility and security devices that once gave their executives comfort such as offshore trusts, haircut provisions, or the right to terminate plans. Unfortunately, relatively few alternatives have been available to secure nonqualified benefits. Even more, executives and professionals seek the freedom and flexibility to self-direct investment contributions with tax-advantaged dollars, the time and safety to grow the contributions tax-deferred, and the benefit and timing of non-taxable distributions. These “highly compensated” professionals face unique retirement issues, especially as partners in professional service firms. Typically, these firms organize their business structures as limited liability corporations (LLCs) or limited liability partnerships (LLPs). Under these structures, traditional deferred compensation plans are not tax-advantaged. When a partner defers compensation, his or her tax deferral is paid today by the remaining partners, who can only hope that deferral payments can be recaptured in later years. In the spirit of our recent white paper, we are introducing the latest solution to firm-sponsored retirement savings programs—Professional Roth Plan (PRP). Before we offer its mechanics, let’s further expand its need and application.
Core Issues In professional partnerships, LLCs, and ‘S’ Corporations, the top earners are the firm’s most valuable assets. Retention of these highly compensated individuals is critical to financial stability and future growth of the company. Additionally, senior partners who may wish to retire, but cannot due to inadequate savings, may be forced to continue working to build more retirement money. The Professional Roth Plan goes directly to the core of how to accumulate the wealth we need to retire comfortably. Effective benefits retain effective talent.
Challenge or Opportunity? Essentially, all retirement planning experts agree that to maintain our lifestyles after retirement, we need to have saved enough to produce an annual retirement income stream equal to 75 percent of what we earned while still employed. However, life expectancy is now into our 80s and retirement income must now take into account the impact of inflation. A rough formula quickly shows how individuals earning $100,000 annually should expect to save at least $1,000,000 before they can expect to retire comfortably. However, if your income is $500,000 a year, in all likelihood, you will need to accumulate at least $5,000,000 during your working years if you desire a comfortable retirement. Without question, the most effective way to accumulate wealth in advance of retirement is to save and invest on a pre-tax basis. That’s simply because, when you invest $1 in a pre-tax plan, the entire $1 is actively working to earn returns versus the 60 cents, or so, available after taxes on the amount earned. Obviously then, everyone eligible for participation in a 401(k) plan, Keogh or cash balance retirement savings plan should contribute as much as allowable by the plans. Clearly, investments made outside the pre-tax environment of a 401(k) cannot be expected to catch up to pre-tax investments—assuming the same level of investment risk and tax rate because those investments begin with a balance roughly 40 percent lower than their pre-tax alternative.
Stretch Beyond Limits
The point is, to attract and retain top talent, all business entities must provide benefit programs that allow their most highly valued performers and contributors to accumulate sufficient wealth to ensure comfortable retirement—or risk losing them to competitors. With the predicted shortage of executive talent as baby boomers retire, the arrival of the PRP is well-timed. In contrast to professional partnership firms, publicly traded companies commonly provide top earners with supplemental financial benefit programs, such as nonqualified deferred compensation (NQDC) plans, in addition to various equity-based incentives. NQDC plans offer their highly compensated participants the benefits of pre-tax saving and tax-deferred investment growth without the limits on annual contributions imposed by qualified plans. Let’s review NQDCs for a moment.
Benefit Liability Obligations Participants in NQDC plans can often contribute up to 100 percent of their total compensation each year on a pre-tax basis. In these arrangements, the company offering the retirement benefit plan cannot take the current deduction on the amounts contributed by participants. Simultaneously, the company accrues a future liability and, possibly an unfunded liability obligation that can easily become significant as years pass. Consider the example of a deferred compensation plan into which 100 participants each contribute $20,000 annually, which results in the company accruing a future liability of $2 million. After ten years, assuming average annual investment returns of 8 percent, the company offering such a plan would have a balance sheet liability in excess of $30 million. At publicly traded companies, however, the increasing liabilities inherent to such executive retirement programs are made more manageable by deferred tax credits available to the sponsoring corporation. Additionally, by informal funding the plan’s liabilities (where contributions are set aside and invested by the company in order to create an asset) the benefit plan’s growing liability can be matched or offset.
Partnership Limitations At professional partnerships, LLCs, and ‘S’ Corporations, those business entities in which the taxes on profits (or losses) are passed through to the partners, members, or shareholders, such deferred compensation arrangements are rarely, if ever, offered. Partners in these non-tax-paying entities, and the entities themselves, do not receive the same tax treatment as in a profitable publicly traded ‘C’ corporation. Some partnerships have turned to SERPs (Supplemental Executive Retirement Plans) to provide top talent with some, or even all of the retirement income needed. However, SERPs are funded by the company versus by participant contributions, which create significant future liabilities for the business entities. SERPs can place enormous financial pressures on firms when participants retire and the benefit plan’s obligations must be satisfied. Unfortunately, more than one firm has collapsed under the weight of their unfunded SERP. The fact is, professional partnerships (and LLCs, or ‘S’ Corporations) have always been limited as to what they can provide top talent by way of wealth accumulation vehicles. The prudent and preferred options have been limited to 401(k), Keoghs, cash balance plans and taxable cash in the form of annual bonuses.
The PRP Solution The newly available PRP retirement savings program provides a win-win solution for all professional partnerships, and similarly structured business entities, that seek to retain top talent with cost-effective, meaningful retirement savings and wealth accumulation benefit programs. The PRP balances the needs of the professional partnership, LLC, or ‘S’ Corporation, with the needs of highly compensated individual participants. Here’s a quick snapshot:
Assuming the policy is held to maturity, the key advantage within institutionally priced insurance vehicles is that all investment gains and future withdrawals can be structured as non-taxable to participants, somewhat like a Roth plan. And, the specially designed insurance vehicle has 100 percent cash value in the first year with a special enhancement feature found only in corporate-owned life insurance contracts.
Participant Advantages From the participant’s perspective, the PRP’s advantages include:
In order to fully appreciate the advantages provided by the PRP, consider the following simplified example of a 45 year-old investing for seven years, earning returns of 8 percent net annually:
Inside View Let’s say that you were to receive a $100,000 bonus at year’s end. After paying all applicable federal and state taxes, you would have approximately $60,000 to invest. By contributing that amount to your PRP account, the amount becomes $100,000 again through the unique structure of the plan. When you deposit your after tax $60,000 into your account, the insurance carrier immediately “loans” your account the $40,000 you paid in taxes, so you have the entire amount earning interest on the investments you select. In effect, this $40,000 is a non-recourse “policy loan.” However, assuming the policy is held until maturity and you do not pay it back, it is simply deducted from the policy’s death benefit. And, the policy loan’s interest rate or carrying charge is only LIBOR + 1.5 percent (roughly the prime rate minus one); that rate as of July 2008 is 4.18 percent. PRP Future Impact Consider this summary illustration of the PRP as a retirement savings plan: If you never contributed to the plan again after the seventh year, and you chose to receive $154,941 per year beginning in year 15—for 15 years—you would receive $2,324,115 in your lifetime, plus provide your named beneficiary with an additional $1,516,322 upon your death (assumes death at age 82). This is accomplished all for an invested amount of $420,000 over the first seven years. The chart below brings this message home:
After considerable due diligence on the Professional Roth Plan, we are confident that the dynamics and upside potential of the plan is ideally suited to plan sponsors and top earners at partnerships, LLCs, and ‘S’ Corporations. In our assessment, the PRP, as compared with any reasonable alternative, offers several exceptional advantages, and a real solution, for an often overlooked and productive business sector—private companies and professional partnerships. With the subject of retirement integral to quality of life issues, it is imperative to seek out solutions that can make a meaningful difference in the lives of many. The Professional Roth Plan is that solution.
Investors should consider the investment objectives, risks and charges and expenses of the contract and underlying investment options, risks carefully before investing, The prospectus contains this and other information about the investment company and must precede or accompany this material. Please be sure to read it carefully. The opinions, estimates, charts and/or projections contained hereafter are as of the date of this presentation/material(s) and may be subject to change without notice. RCG endeavors to ensure that the contents have been compiled or derived from sources RCG believes to be reliable and contain information and opinions that RCG believes to be accurate and complete. However, RCG makes no representation or warranty, expressed or implied, in respect thereof, takes no responsibility for any errors and omissions contained therein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this presentation/material(s) or it contents. Information may be available to RCG or its affiliates that are not reflected in its presentation/materials(s). Nothing contained in this presentation constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any investment product. Investing entails the risk of loss of principal and the investor alone assumes the sole responsibility of evaluating the merits and risks associated with investing or making any investment decisions. Securities Offered Through Retirement Capital Group Securities,
|
For firm partners, a serious challenge lurks in the limits imposed by qualified retirement savings programs. For example, the 401(k) plan is only marginally valuable for sufficient retirement savings. If your annual income is $500,000 pre-tax contributions are limited to three percent of that income. And that three percent will never grow to the 75 percent you will need to maintain your lifestyle at retirement. Of course, there’s always a part-time job.
Another key PRP feature restores taxes during the accumulation period. For example, if you deposit $60,000 after tax, the PRP restores $40,000 to your accumulation assuming your tax rate is 40 percent. The cash values are directed by the participant into 60-plus mutual funds from leading investment managers. Better yet, the policy does not impose surrender charges; participants are free to withdraw their funds as they see fit. We caution that early withdrawals can negatively impact the financial performance of the plan.