Case Studies

Case Study Profile

Business Type:

Insurance Broker

Business Entity:

Subchapter "C" Corporation

Owner's Income:

$150,000 earned income reportable on W-2 prior to bonus at year end

Projected Profit

$150,000 prior to plan contribution

Owner's Age:

Marital Status:

Single

Employees:

None

Plan Objective:

Maximize tax deductible contribution to provide maximum retirement benefit

Comments:

This individual chose the Subchapter "C" entity form to permit 100% deduction of medical insurance benefits. However, starting in 2003, health insurance benefits are 100% deductible for shareholder/employees in a Subchapter "S" Corporation and individuals who file taxes as a self-employed individual so the broker changes his entity type from a C to an S corporation.

$44,000 with the SEP or Mini(k) in 2006 but...

The contribution comparison provided above indicates that the Mini(k) offers no advantage over the SEP. In this instance, the SEP appears to permit the physician to contribute the law's maximum deductible contribution absent the requirement for formal plan documents, governmental reporting and disclosure and the additional cost for professional services typically associated with these requirements.

However, since the Mini(k) is a Profit Sharing Plan with a 401(k) feature, it can be combined with a Defined Benefit Pension Plan (DB). As shown below, the combined Defined Benefit and Mini(k) Plans provides the broker with a higher deductible contribution than the SEP.

Learn more about the combination Mini(k) and Defined Benefit Pension Plan and how the interrelationship of the individual contribution/benefit and employer deduction limits permit this dynamic plan design.

$73,600 more than the SEP in 2005!

The $73,600 differential increases as the 401(k) limit increases since the Mini(k) is a Profit Sharing Plan with a 401(k) feature. The differential also increases if the maximum defined benefit pension limit increases as it did in 2006 to $175,000 up from $170,000 in 2005.

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What's the catch? Just one, in reality the Mini(k)Plan is a Profit Sharing Plan with a 401(k) feature. This means that both the Mini(k) and the Defined Benefit Plan (DB) are qualified retirement plans subject to numerous government compliance requirements. If you don't comply with these requirements, you can lose the benefits gained by choosing this plan type over a SEP or a SIMPLE. Here's a chart that illustrates just some of the compliance requirements and features for these different plan types.

Compliance Requirements and Plan Features	SEP	SIMPLE	Mini(k)Plan and DB
Formal Plan Document	No	No	Yes
Trust Reconciliation	No	No for SIMPLE IRA Yes for SIMPLE 401(k)	Yes
Annual Filing	No	No for SIMPLE IRA Yes for SIMPLE 401(k)	Yes¹
Rollovers from other Plans and IRAs	Yes	Other SIMPLE only	Yes
Loans Permitted	No	No	Yes
Advantage to add Spouse	No	Yes	Yes
Updates Required by Law	No	No	Yes
Establish New Plan By	Due date of return or any extension	October 1 unless new employer	December 31
Must fund Employee Contribution by	Not Applicable	Corporation: Earliest date employer can transmit contributions. Sole Prop/Partner: by due date or extension.	Corporation: Earliest date employer can transmit contributions. Sole Prop/Partner: by due date or extension.
Must fund Employer Contribution by	Due date of return or any extension	Corporation: by due date of return or extension. Sole Prop/Partner: by due date or extension.	Corporation: by due date of return or extension. Sole Prop/Partner: by due date or extension. Must fund DB within 8½ months to satisfy minimum funding requirement
¹ Recommended but not required until assets exceed $100,000
This chart illustrates basic requirements only. All plans shown may be selected for audit by the government; all require timely and accurate completion of forms and other related documents when established and ongoing. Chart is intended as a resource only; consult a professional before implementing any plan.
This chart illustrates basic requirements only. All plans shown are subject to audit by the government; all require timely and accurate completion of forms and other related documents when established and ongoing.

View comprehensive chart for these plan types: "Compliance Requirements and Limits"

View comprehensive chart for these plan types: "Available Benefits and Features"

Closing Comments

A SEP or SIMPLE plan is traditionally the appropriate plan type for a single owner business entity or an independent contractor (self-employed individual). These plan types do not require formal plan documents or governmental reporting and disclosure and the additional cost for professional services typically associated with these requirements. Both the Min(k) (Profit Sharing Plan with a 401(k) feature) and the Defined Benefit Pension Plans are qualified retirement plans requiring formal plan documents and governmental reporting and disclosure.

The maximum deductible contribution to a SEP is the lesser of 25% of compensation (earned income) or $44,000 (increased from $42,000 in 2005). As shown in the chart above, this means that the insurance broker with at least $176,000 of W-2 earned income can contribute the law's maximum deductible contribution to either the SEP or the Min(k).

However, the combined Min(k) and Defined Benefit Pension Plan provides the insurance broker with a $73,600 higher deductible plan contribution and a significant increase in benefits at retirement. The $73,600 differential shown above reflects the $15,000 401(k) limit for 2006 (up from $14,000 in 2005) and the $175,000 maximum defined benefit limit for 2006 (up from $170,000 in 2004).

Bottom Line: In the example above, if the insurance broker desires a deductible plan contribution of $44,000 or less, the SEP is the preferred plan since it does not require formal plan documents, and governmental reporting and disclosure. Be mindful that the SEP typically requires the inclusion of part-time employees (if they earned $450 or more in any 3 out of the prior 5 years) and, unlike the Mini(k), it does not permit the additional "catch-up" contribution for individuals age 50 or older ($5,000 in 2006). In addition, the increase in the SEP contribution limit from 15% to 25% portends that reporting and disclosure requirements may eventually apply to SEPs. Lastly, the SEP does not facilitate the inclusion of a spouse working for the business.

If the insurance broker desires the maximum deductible contribution permitted by law, the combined Mini(k) and Defined Benefit Pension Plans are the preferred plans. The associated cost to establish and maintain the combined Min(k) and Defined Benefit Pension Plans is justified based on the additional tax savings and the dramatic increase in benefits at retirement.

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The information provided is intended as a general resource, not as investment or retirement planning, or legal plan compliance advice or counsel. If you consider any actions discussed in this update, we suggest that you consult a qualified planning, tax or ERISA professional. ERISA Expertise LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update. Any tax advice included in this written or electronic communication is not intended or written to be used, and it cannot be used, by the taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.