Overview
About six years ago I wrote an article that I posted on JD Supra regarding the ability of business owners to exclude employees from participation in the company pension plan by relying on a Department of Labor exemption for union employees.
You would have thought that such an idea might be appealing. My Dad and brother called me to see that they saw the article online but that was the extent of it. At that time, I focused the concept on fully insured defined plans which were just coming off of a period of small pension plan audits by the IRS.
When I attended the University of Miami School of Law (Harvard of the South for the rest of you!) and worked in the life insurance business during the day in a National Life of Vermont agency, the same agent led the company in sales, year-in and year-out. It was always a great mystery to the other agents what his big sales concept was. The only leaks from home office personnel revealed that it had something to do with pension plans and unions. With a little reverse engineering, it became clearer to me what the concept was all about. The problem is depending what part of the country you are from, is the belief that telling someone to join a labor union is akin to asking someone to join the communist party during the McCarthy era. The reality is that is nothing like that.
Six years later, the concept is still as viable as it was in the early 1990s as well as six years ago. Nevertheless, when it comes to a discussion about labor unions, emotions run very high. Business owners typically shake in their boots and conjure up images of picket lines outside of their business and images of Jimmy Hoffa wearing cement shows in the bottom of the East River. Some employees might say that any job even with no pension plan or benefits is better than not having a job at all. Like fishing stories, union stories become more outrageous each time they are told.
Unless you work for the federal, state or municipal government, or as a first responder, i.e. police, fire or military, you won’t receive a pension. My definition of a pension is a defined benefit plan. 401k plans are savings plans that were never intended to replace defined benefit plans which have virtually disappeared from the landscape over the last three decades. An employee should consider himself fortunate if his company matches his contribution to the company 401k plan.
From the business owner perspective, the benefit of qualified retirement plans often loses a lot its luster due to the requirements to provide non-discriminatory participation and benefits for employees. It suddenly makes the plan expensive when the business owner has to contribute for someone else other than himself.
This article focuses on the pension plan design in order to maximize tax deductible contributions and retirement benefits. Unlike my prior article, this version will focus on traditional plan design with “bells and whistles” designed to maximize the benefit to business owners.
IRC Sec 410(b)(3)(A) provides an important exception to the minimum participation rules of qualified retirement plans. This Code section exempts employees that are covered for retirement as well as health benefits under a collectively bargained agreement. By the end of the story, I will be able to show you how to get more than 99 percent of pension contributions at a level that are 6-10 times higher than the level the business owner is taking now.
What Are the Requirements of Qualified Plans?
The ability of a business to make a tax-deductible contribution to a retirement plan comes with all sorts of requirements – (1) Minimum Participation (2) Top heavy rules (3) Non-discrimination (4) Minimum coverage (5) Minimum vesting requirements and (6) Minimum funding requirements. At the same time, the business owner is handcuffed with respect to the maximum contribution under the defined contribution rules - $50,000 in 2012 and the maximum annual compensation that can be considered - $250,000.
Compliance with these rules inevitably limits plan considerations and contribution levels for the business owner due to the cost constraints of employee benefit contributions. The best option in most cases is a defined benefit plan – traditional or fully insured. Other ERISA benefit plans have similar minimum participation and coverage rules. The exemption for collectively bargained agreements eliminates these tax and regulatory obstacles.
In the best-case scenario depending upon the particular circumstances, a skilled pension administrator may be able to design a pension plan so that the business owners receive 93 percent of the contributions. That is still pretty good, but it is not 100 percent. Many business owners prefer not to make any contribution for the benefit of employees if possible.
Collectively Bargained Arrangements under IRC Sec 410(b)(3)(A)
What is a collectively bargained agreement? IRC Sec 410(b)(3)(A) states the following in its exemption:
“employees who are included in a unit of employees covered by an agreement which the Secretary of Labor finds to be a collective bargaining agreement between employee representatives and one or more employers, if there is evidence that retirement benefits were the subject of good faith bargaining between such employee representatives and such employer or employers,”
As a result, company employees pursuant to a collective bargaining agreement become union members and the business makes contributions to the union retirement and health plans instead of the company plans. These contributions to the union plan are tax deductible. As a result, these employees are no longer part of the company pension plan or benefits program. The business owner is free to establish a define benefit plan as well as a medical reimbursement plan. The only remaining employees eligible for participation in the business owner’s plan are the business owner and family members. Benefit plan contributions can be optimized for the business owner.
Union Friendly – Telling the Emperor that He Still Has No Clothes
Inevitably, the biggest worry of every business owner or professionals when it comes to unionized employees is the fear of the union itself. Public sentiment towards unions is politically charged and divisive. Most people either love unions or hate them.
The ‘haters’ attribute politically the economic demise of the manufacturing sector to union greed over the last several decades. On the other hand, most union members that are covered by collectively bargained agreements are participants in multi-employer defined benefit plans and will have post-retiree health insurance coverage. In the meantime, the rest of us are lucky to have a company match on our 401(k) plans, or participation in a company profit sharing plan funded with company stock that has gone down by forty percent. For the latter group, the target retirement age is age 95.
No one can make an employee join a union. The business owner cannot pay the union dues for his employee. In most cases, he will contribute at least 3 percent of employee salaries into the union 401(k) plan.
A business owner should see this strategy as a means to an end – a comfortable retirement and lower taxation. The business owner needs to take off his Make America Great Again “political hat” to evaluate the economics of this strategy. Most business owners assume the worst believing that long term employees who join the Union on Friday will be outside of the business picketing the following Monday for higher pay and paid vacations as well as becoming members of the communist party. The reality is that the unions need the business owner as much as the business owner needs the business. The key to this strategy is working with “friendly” unions and maintaining an ongoing stable relationship. Most “friendly” unions need members and have no interest tampering with the small business.
Pension Plan Overview
The traditional retirement configuration in small businesses is typical a combination of a 401(k) and profit-sharing plan that allows the business owner to defer up to $56,000 in 2019. The business owner can defer up to $19,000, If the business owner is age fifty or older a “catch up” provision allows an additional contribution.
Pension owners become much more interesting to business owners when a cash balance defined benefit plan is added to the planning mix. For the younger business owner (say ages 40-44), the combination of plans -401k/profit sharing and cash balanced defined benefit plan can increase the level of contribution by 300-500 percent. For the older ages (say 60-65), the level of contribution can increase by 600-1,000 percent.
The use of the collective bargaining exemption can assure that all of the contributions are made on the behalf of the business owner. The level of contributions and benefits can be accelerated through the addition of a series of ancillary benefits
- Spousal Benefits – The business owner can add a spouse to the payroll and provide benefits increasing the level of deductions to the business.
- Double Pension Contributions in Year 1- The business owner can make two pension contributions in Year 1 by having the first year as a short year. For example, Plan Year 1 may have a year end of November 30 and Plan Year 1 may have a beginning date of December 1. This strategy can double the amount od tax deductible contributions in the first plan year.
- IRC Sec 401(h) Post Retirement Medical Expense Reimbursement – It is shocking that this special benefit is so little known. This benefit provides for an additional contribution to the pension plan. The payment or reimbursement of post-retirement medical expenses. The contribution limit is $56,000 in 2019. The contributions are tax deductible, tax deferred and benefit payment tax-free. Amazing! Unused annual contributions can be carried forward to future years.
- Pre-COLA Funding provides for a pre-and post-retirement death benefit within the plan. The amount of premium is not limited, and the death benefit cannot exceed the amount of the monthly benefit.
Strategy Example
In the article, I stated that the result for the business owner, even if you include the employees is pretty good for business owners. Nevertheless, some business owners do not want to provide pension benefits for their employees. Period! The example will outline the benefits for the business owner using the union option and without using the union option.
Juan Doe, Age 55, is the owner of Acme Widget. He has one highly compensated employee, his chief operating officer (COO) and four other employees. The COO is paid $120,000 per year and the four employees make between $20,000-50,000. Collectively, the annual payroll for the COO and four employees is $515,000 which includes Juan’s annual W-2 income of $265,000 per year.
In the event that Juan decides not to exercise the collective bargaining exemption, this is what he can expect. In this scenario, he would like to budget so that he receives at least $400,000 in the company contribution. The plan design includes a 401k/profit sharing plan, a cash balance defined benefit plan, a 401(h) post-retirement medical expense plan and Pre-COLA funding. The funding for Juan provides for a $275,000 contribution to the cash balance defined benefit plan is $275,000. An additional $39,750 is funded into the 401k/profit sharing plan, and $20,100 into a 401(h) account. An additional $ is funded into the Pre-COLA. The total funding on behalf of Juan is $400,000. The funding for the employees is $18,250. Juan personally receives 95.7% of the funding. The total amount of funding for the company is $418,250.
In the second scenario, Juan decides to utilize the bargaining agreement and decides to add his wife as an employee of the company with W-2 income of $150,000. As part of the collective bargaining agreement, Juan will make a 3 percent contribution to Union 401k plan on behalf of his employees - $10,500. Additionally, since this is the initial plan year, Juan will configure the initial plan year so that it ends on 11/30. The second plan year will begin on 12/1. The combined cash balance contributions for Juan and his wife are $1,175,000 for 2019. The combined 401k and profit-sharing plan contributions are $111,400. The combined 401(h) contributions are $121,300. The combined Pre-COLA contributions are $242,767. The total pension contribution for Juan and his wife is $1,630,000. The pension contribution to the Union as a percentage of the total contribution for Juan and his wife is less than one percent (.65%). After taxes, this percentage is further reduced to a negligible amount.
Summary
If you are highly compensated with substantial independent contractor income or own a business, and you are not looking at these ideas, shame on you! There is a lot of uncertainty in the world except for the certainty Death and Taxes. I can help you with the second problem. The timing of this article is intentional on my part. It is not too late to implement this strategy for this year and going forward. The actual funding except for 401k funding may be delayed until next year. Operators are standing by waiting for your call!
