Preparing for the Long-Term:
DR-VIP Retirement Plan Offers More Flexibility and Lowered Risk
By Scott M. Sachs, CPA
As I talk to Los Angeles-area executives, there's a consistent theme that comes up again and again: adapting to what has become the "new normal" of today's economy and its impact on their businesses and personal finances. As executives are adapting to what economic uncertainty means to their long-term future, they are often looking for strategies that reduce risk and improve retirement plan savings for themselves and their management team. Professional firms, such as production companies, law firms, medical practices, private equity firms, investment banks, and asset management firms, have an opportunity to do just that by establishing asset-linked qualified retirement plans in order to maximize deductible contributions for partners, shareholders, and other key people.
Through an option called a Direct Recognition Variable Investment Pension Plan ("DR-VIP Plan"), firm partners benefit from large, tax-deductible contributions without the underfunding risk and complications.
A DR-VIP Plan, a tax-qualified "cash balance"-type retirement plan designed for partners and shareholders of professional firms, provides that a participant's account balance increases or decreases in direct recognition of the return on investments. Thus, and importantly, DR-VIP Plans provide the high level of benefits (contributions) available under a traditional defined benefit or cash balance plan without the underfunding risk. As a result, annual contributions are predictable, accounting costs are consistent, and investment flexibility is dramatically expanded. With these characteristics, the DR-VIP Plan has rendered traditional cash balance plans obsolete.
DR-VIP Plan characteristics include:
- Tax deductible contributions to $285,000 per participant (versus the $50,000, or $55,500 if age 50, limit in most plans)
- No over/underfunding
- Consistent and reliable annual contributions
- Plan assets exempt from creditors
- Plans submitted to the IRS for favorable determination letter
- Assets are managed and invested as designated by the plan sponsor
- Participant account balances track in direct recognition of investment results
- 24/7 online access to participant account balances and reports
DR-VIP Plans can generally be established up until the last day of an employer's fiscal year. Plan designs can be customized to distinguish between contributions made by and/or for senior-level executives and those made by staff, truly allowing each business to create a plan that fits its facts, circumstances, and objectives.
Partnerships of all sizes are in a prime position to take advantage of DR-VIP Plans. If a cash balance or defined benefit plan already exists, a new plan can be designed that will replicate the benefits, while eliminating underfunding risk and unpredictable future contribution requirements.
Many DR-VIP arrangements include a financially integrated profit sharing plan and 401(k). In such circumstances, modest increases for staff often result in significant additional and targeted contributions for the benefit of partners or senior management.
Assets in DR-VIP plan accounts are exempt from claims from creditors. For partnerships such as medical practices, this is important to keep in mind since they are protected in cases such as malpractice.
I've seen this work extremely well for many clients. In one situation, we designed a plan for a seven-member partnership. The partners had been contributing a total of $358,000 annually (approximately $51,000 each) to their old plan. The DR-VIP design allowed the partners to contribute at different levels depending on specified objectives and firm characteristics. Contributions for the benefit of partners increased to more than $1.5 million with the top individual contribution at more than $250,000, while the contribution for the benefit of staff and associates increased by only $63,000. At the same time, underfunding risk was eliminated, and future funding requirements will remain consistent with objectives and be subject to adequate profitability.
Another client, a two-member LLC, increased contributions for the two partners to more than $200,000 each with approximately $4,500 in additional annual contributions allocated to staff.
This option may be a strategic solution for a variety of businesses. In uncertain times, planning techniques like this can make a significant impact on executives' long-term goals and peace of mind.