Maximizing Tax Deductions and Optimizing Owner Benefits-Large Company

The Setup

Navajo Industries, a 700 employee company, sponsors a safe harbor 401(k) plan.  Navajo has three owners, Jerry, Georgia, and Bill. There are 30 executives and salespeople that have compensation in excess of $120,000 (i.e. Highly Compensated Employees or HCE’s).

 

Jerry, Georgia, and Bill are 64, 58, and 56 years of age respectively. They each maximize their 401(k) at $23,000 and receive match of $10,400.  Each has also consistently made in excess of $500,000 in compensation.

 

They inquired to their 401(k) provider (a large multi-billion dollar investment house) if there was a way for them to contribute more for the three owners “without breaking the bank”. They got a resounding “NO.”

The Conflict

The owners have not saved nearly what they would like or feel they need to provide substantial income in retirement. They always thought they were limited to approximately $33,000 in contributions. To insure passing 401(k) testing requirements, they are currently contributing $422,000 in safe harbor match. Their goal was not to reduce employee benefits, but to add on a benefit for themselves in the most cost effective manner.

The MGO Solution

One of Navajo’s advisor’s had regularly attended MGO’s annual creative planning seminar. He contacted MGO and asked our opinion. MGO then obtained Navajo’s annual census information and allocation data from the national firm.

 

After analyzing the data, MGO recommended a two pronged approach.  First, we recommended adding “cross tested” allocation provisions to the 401(k) plan currently in place.   By adding cross testing, we were able to add flexibility in how the plan’s profit sharing contribution is allocated across participants.

 

Second, we recommended adding a Cash Balance plan. The Cash Balance was designed to cover the three owners and the minimum number of non-highly compensated employees (NHCE’s) to satisfy IRS coverage rules.

 

Forty-seven was the minimum number of NHCE’s needed to satisfy the rules, but the new plan still needed to meet IRS reasonable classification requirements (i.e. selecting a definable group of individuals such as a particular job class or geographic location).  So, Navajo decided to cover two different job classes, their administrative assistants and help desk agents. This brought the number of NHCE’s covered in the Cash Balance to 62.

 

The results are as follows:

 

	Age	401(k)	Match	Profit Sharing	Cash Balance
Jerry	64	$23,000	$10,400	$24,100	$249,500
Georgia	58	$23,000	$10,400	$24,100	$210,600
Bill	56	$23,000	$10,400	$24,100	$189,200
Total		$69,000	$31,200	$72,300	$649,300
Employee Increase				$19,000	$24,000

 

 

The planning resulted in an increase of $721,600 in contributions for the three owners for an additional employee cost of $43,000. Jerry, Georgia, and Bill are receiving 94.37% of the increased contribuition.

 

The owners said to MGO, “This is a no brainer!” and implemented the planning ideas recommended. They moved their 401(k) plan to MGO and implemented the Cash Balance plan.