Vermont Bar Association Seminar Materials

Do You Have What It Takes To Retire? A How-To Guide

September 19, 2014 Killington Grand Resort

Killington, VT

Faculty:

John Cole, Esq. Mark Melendy, Esq.

John H.W. Cole, P.C.

3 Worcester Street South Burlington VT 05403-7235

(800) 443-0264 - Toll Free (802) 497-3190 - Facsimile

Jcole@erisajd.com

John H.W. Cole, Esq. What is your life expectancy? How much will you need to save for retirement? What is the fastest way to save for retirement? What type of retirement plan should I choose? What plan options should I choose? All that and more….

Vermont Bar Association

2014 Annual Meeting

September 19, 2014

Do You Have What it Takes to Retire? By: John H.W. Cole, Esq.

Life Expectancy

In the mid-19th century the average life expectancy across the globe was age 40. 100 years later, in 1950, life expectancy was age 48. By 1980 global life expectancy jumped to 60 years, and by 2010 to age 70, according to data from the International Monetary Fund. The dramatic surge in recent years was largely a result of a decrease in infant mortality.

Starting in 1970 a significant improvement in life expectancy for people over 65 began. It continues today, with the most significant impact being on the oldest, those aged 85 and over. One in four 65 year old Americans is projected to live past age 90. The Society of Actuaries updated life expectancy tables, which will be published later this year, will show the median American is living 2.2 years longer than a decade ago. The average 65 year old will live 22.7 more years, to age 87.7.

A recent Time Magazine article reviewed mortality statistics in the context of economic status, and those at the top of the income scale live ten years longer, on average, then those at the bottom of the scale. Finally, a factoid that pulls these statistics together, really counts: According to the Boston College of Retirement Research (crr@bc.edu) in 1970 Americans saved about 12% of their after tax income. Today that’s plummeted to less than 6%.

How Much In Savings Do You Need To Retire Comfortably?

Kiplinger’s and Money magazines, as well as the AARP, have calculators on their websites to help make this determination. So do most financial planners. The difficulty with using these tools is making them fit an individual’s situation. Lawyers’ income, particularly in a small practice, can vary greatly from year to year depending upon market forces, such as real property sales, and the finances of their clients.

Some articles on the subject focus on replacement ratios and are based upon when an individual starts saving. Under this approach for replacement income at age 65

to equal 70% of your current income you need to save 10% each year if you start at age 25, 15% starting at age 35, and 27% starting age 45. Followers of this approach disagree on what the replacement ratio should be, with the lowest using 60% and highest using 100%.

I recommend that you calculate your own needs, starting with your current income and expenditures. The biggest items among them will be saving for college for your children, and your home mortgage. If those large expenditures are taken care of by the time you retire, you need to replace less income. As for the rest of your expenditures, I can’t see many of us saying we want to reduce our lifestyle at age 65 and many of us will spend more because we’ll finally take long vacations, instead of a four day weekend.

Use the income number you need after subtracting the home mortgage, if paid off at age 65 and college for your children, if that obligation will have ended. Compound that income number to age 65 by multiplying by 1.02 to the power that reflects the number of years to age 65. That will tell you the income stream you need. Subtract out the social security you will be receiving, and that will leave the income you’ll need. More is always better when it comes to saving for retirement, but you should at least try to set an income target.

How Much Money is Needed to Fund the Income Stream at Retirement?

How much is needed depends upon the rate of return on your investments. From the 1970’s to the beginning of the 21st Century rate of return estimates were in the 8-9% range, reflecting earnings ratios during that period, which lasted 30-35 years. Today, the range is from 4% to 6%. With the Federal Reserve deliberately holding down interest rates and with stock values at fairly high price earnings ratios, I recommend planning on investment earnings continuing to be into the 4-6% range for the foreseeable future. At a 4% earnings rate you would need $1,000,000 in savings to yield $40,000 per year. At 6% the resulting earnings would be $60,000 per year.

One approach is simply to work past age 65. Retirement at age 70 would cut your required annual savings in half. Such a game plan contains a risky assumption that you are healthy enough to work just as hard through age 70 as you do today.

Do You Have What it Takes to Retire? John H.W. Cole, Esq. Page 2

According to the Employee Benefit Research Institute 47% of retirees leave the workforce sooner than planned.

What is the Best Way to Accumulate the Necessary Savings?

The best way to accumulate savings is in a pre-tax savings vehicle. Illustrations 1-1 and 1-2 show the results of funding $23,000 per year into a qualified plan starting in 2014 at age 45.

In the after tax account $321,652 is accumulated through age 65. $687,828 is accumulated in the plan account. The key to maximizing the plan advantage is to withdraw only what is needed, and to continue to accumulate the balance tax free. In Illustration 1-2 the amount withdrawn is determined by dividing the beginning balance plus earnings minus taxes by the projected life expectancy of 25 years, in the first year, and by one year less in each year thereafter. Thus, the divisor for 2032 is 24. Lower tax brackets at retirement are assumed, which is the experience of those who are not independently wealthy.

The spendable income for 2031 from the after tax account is $13,495. The after tax spendable income from the plan account is $23,754. Over the 25 year period the total after tax, spendable income from the qualified plan is more than twice the amount available from saving outside of a qualified plan. Illustrations 2-1 and 2-2 show the results at a higher income and funding level. Once again, the after tax income through a qualified plan is more than double that available using the after tax account.

Qualified Plans

The balance of this session will be devoted to qualified plans, the choices available to you when establishing a qualified plan, and the reasons for making one choice or another. This is particularly pertinent today because the plan restatement period is upon us. The Internal Revenue Code provisions, regulations, and IRS Rulings and Notices are in a constant state of change. So that plan maintenance is not overwhelming the IRS Procedures provide for updating plan documents every six years for plans with pre-approved provisions and every five years for custom plan documents. Plans with preapproved provisions are either prototype plans or

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volume submitter plans. In the interim the IRS issues notices as to “good faith” amendments that must be adopted promptly and can’t wait until the next update period.

For almost all profit sharing and 401(k) plans the update period began April 1st of this year. The period ends March 31, 2016. The determination that the existing plan document is qualified expired March 31, 2014. However, a restated plan document which is adopted within this two year period (and submitted to the IRS for a determination letter, where applicable) will be retroactively effective to April 1, 2014. The bankruptcy code and most state creditor laws provide special protection to interests in qualified plans. To have that protection the plan must be qualified. The issue thus arises whether a plan that has not been updated yet can be considered qualified for bankruptcy and state law protection purposes. I am not aware of this issue being addressed by either state or federal courts and bring it up as a precaution.

In addition to the need for an update, a good faith amendment concerning the plan’s definition of marriage must be adopted by the due date of the 2014 tax return of the plan’s sponsor. The language of the prototype plans and volume submitter plans was submitted to the IRS before U.S. v. Windsor, the Supreme Court case recognizing gay marriages for tax purposes. Accordingly, the new plan documents probably won’t contain Windsor compliant language, and a separate amendment will be needed.

Discrimination and Coverage Requirements

In order for business owners to obtain the tax benefits of a qualified plan the plan must meet certain discrimination and coverage requirements. The tests for meeting these requirements are based upon a comparison of the treatment of two groups: the highly compensated (HCE’s) and the non-highly compensated (NHCE’s). Generally, under the Coverage Requirements the participation ratio of the NHCE’s must be 70% of the participation ratio of the HCE’s. For example, if one HCE and four NHCE’s have met the plan’s eligibility requirements, then 70% of the four NHCE’s (i.e., three NHCE’s) must participate in the plan’s allocation for the plan year.

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The discrimination requirement is that the allocations to HCE’s and NHCE’s must not be discriminatory (explained further below). The discussion below applies to both profit sharing and 401(k) plans, except as specifically noted.

Eligibility Requirements

The coverage test only applies to employees who have met the plan’s eligibility requirements. A plan may require a maximum of two years, one year, or less than one year. If a plan has an eligibility requirement of more than one year then it must provide for full and immediate vesting of profit sharing allocations. The 401(k) portion of a plan may not require more than one year of service.

Forty years ago plans would commonly exclude part time and only cover full time employees. The words “full time” and “part time” were considered imprecise so in 1974 the rules were changed to express eligibility requirements in terms of years of service. A year of service for eligibility purposes is a 12 month period, starting with an employee’s date of hire, in which he works 1,000 hours. For example, if an employee is hired July 15, 2014, and works 1,000 hours by July 14, 2015, he has completed one year of service. 1,000 hours in a twelve month period is approximately 19.23 hours per week, the current measuring stick for determining full time or part time employees.

If a plan has an eligibility requirement of less than one year (such as a six month eligibility requirement) then hours aren’t counted. An employee has met eligibility requirements as to service once the eligibility time period has been met. This means that employees otherwise considered “part time” will enter the plan at the same time as “full time” employees. This can cause a conflict with the plan’s accrual rules.

Accrual rules state the conditions for receiving an allocation. A plan may require completion of 1,000 hours of service (or fewer hours, or none) and/or may require employment on the last day of the plan year.

Part time employees, however, tend to turn over quickly, and often fail to meet accrual requirements. By allowing part-time employees to become eligible, but not giving them an allocation because of their failure to meet the accrual

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requirement(s) a plan can easily fail the 70% minimum participation rule discussed above.

This is particularly true in a small business, such as a professional firm. Accordingly, to keep plans out of trouble I normally recommend an eligibility requirement of at least one year of service, to separate the part-time employees from the full time employees. In addition I include a coverage “failsafe” clause that permits an allocation to an NHCE who did not otherwise qualify for an allocation, if needed to meet the 70% minimum participation rule.

A plan may also require attainment of a certain age, not to exceed age 21. Keeping an employee out of the plan until he is age 21 may make sense for some businesses, such as a fast food restaurant, but if a plan uses a cross tested formula (explained below) it is often desirable to get younger employees into the plan as soon as possible.

Finally, a plan may have minimum service requirements but credit service with an unrelated employer for eligibility purposes. This is often done when practices, are combined, or to attract certain employees, such as former IRS attorneys to the law firm. The rules here are fairly liberal and plans may easily be amended to let a coveted recruit participate immediately.

Entry Dates

The next consideration is when an employee should enter the plan. The choices range from (1) immediate entry upon completion of eligibility requirements to (2) entry at semi-annual entry dates. With a semi-annual entry date the employee in the above example, who completed his year of service on July 14th would enter the plan on the following January 1st (assuming a calendar year plan). If he had completed his year of service before July 1st he would enter July 1st. The use of entry dates, particularly semi-annual entries assists in meeting coverage requirements because employees who terminate prior to their entry date are not taken into account for purposes of the 70% coverage test.

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Compensation Received Prior To Plan Entry

The next question is whether to take into account an employee’s entire compensation for the plan year of entry or only the compensation paid to him after his entry date. Assume, for example, that a plan has a one year eligibility requirement and provides for entry on the first day of the month following his completion of one year of service. If an employee is hired November 3, 2014 and completes his year of service on November 2, 2015, he would enter the plan on December 1, 2015. If his entire year’s compensation for 2015 is counted for allocation purposes then he will share in profit sharing allocations for 12 of his first 13 months of employment. A fellow employee hired December 2, 2014 would not enter until January 1, 2016 and thus would not share in profit sharing contributions for his first 13 months of employment. The problem here is one of employee relations and their perception of fairness.

If the plan has a 401(k) provision some employers like to use a shorter eligibility requirement in order to attract employees. A plan in this case could have a six month wait to start making deferrals, and a one year wait for profit sharing participation (dual eligibility). The price of having dual eligibility is at the very least more complication. In addition, most plans of small employers are subject to minimum benefit requirements. As a result at least 3% has to be funded for employees who enter earlier for 401(k) purposes.

Vesting

As noted above, if a plan has an eligibility requirement of one year (or less) it can also have a vesting schedule. That means that a participant must complete a certain number of plan years of service to be entitled to his profit sharing account balance (Participants are always fully vested in their 401(k) deferrals). The two choices here are a three year cliff vesting schedule or a six year staggered vesting schedule of 20% per year, beginning with a participant’s second plan year of service.

In a plan with three year cliff vesting an employee terminating employment with two years of service forfeits his profit sharing account balance. If he has completed three years of service, however, he is fully vested and receives his entire

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profit sharing account balance. Years of service for vesting purposes are determined on a plan year basis. An employee working 40 hours per week would complete 1,000 hours of service by mid-June of a calendar plan year, so if he quit in July with two prior years of vesting service he would be fully vested. With a six year staggered vesting schedule an employee takes six years to become fully vested. If he quits with four years of service he would be 60% vested.

A plan may disregard service prior to the plan being implemented, and may credit service with other employers. I recommend disregarding service prior to a plan’s adoption, because prior to a plan’s adoption adequate records might not have been kept as to hours of service.

Safe Harbor Allocation Formulas

Your father’s retirement plan had one of two formulas. Today, these formulas are known as Safe Harbor formulas, and per se are considered nondiscriminatory.

The first, a pro rata formula, is shown on Illustration 4. Larry can fund 25% of pay, but at a high staff cost.

The second formula, shown on Illustration 5, is an integrated formula. That means there are two allocations, one as a percentage of compensation, and one as a percentage of “excess” compensation. In the illustration, the excess allocation is 5.4% of compensation in excess of 80% of the taxable wage base ($93,600), which is not much. If Larry had made $250,000, then his excess allocation would have been $8,446, a more significant number.

Age Weighted Formulas

Modern formulas are much more flexible and can greatly favor the principals, but the price for this is discrimination testing, which compares what the HCE’s receive with what the NHCE’s receive. In most cases testing is done on a benefits basis, called cross testing. The first cross tested formula was an age weighted formula. As shown in Illustration 6-1 each participant is assigned a factor for the plan year, based upon the number of years from the current year to age 65. That factor, multiplied by his compensation, multiplied by a uniform funding factor, determines what he is allocated.

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Illustration 6-2, the rate group test, tests for discrimination by compounding each participant’s allocation to age 65 (the projected accumulation). This result is divided by the cost of buying an annuity to provide his benefit to determine how much of a benefit the contribution will provide. The projected benefit divided by his current compensation provides his accrual rate. As shown, in an age weighted formula the accrual rates are identical. Thus, the results, on a benefits basis are nondiscriminatory.

Cross Tested Formulas

In September of 1993 the IRS issued Regs. 1.401(a)(4) concerning the rules for cross testing. Prior to then all practitioners could do is draft their best estimate of what formulas would be acceptable, file the plan with the IRS, and see how they reacted. The regulations contained two surprises: First, a plan could divide participants into separate groups for allocation purposes, and second, only a percentage of the NHCE’s had to receive the same benefit at retirement for the discrimination tests to be passed.

In Illustration 7 Darryl’s age was changed to 50. At age 50 an age weighted formula would have required an allocation to Darryl of at least $7,000. Under the cross testing regulations, however, only one of the two Darryls had to have an equivalent benefit. A 5% allocation to each Darryl caused the tests to be passed with Larry receiving an allocation of 36% of pay.

With the 1993 guidelines it was now possible for a well-designed plan to have maximum allocations to owners, such as $52,000 each, while allocations to employees range from 4 to 5% of their compensation. Such staff funding falls within the national average, and thus is competitive. For small business owners, however, the tax savings resulting from their higher allocation level and tax free compounding more than makes the staff cost worthwhile. The ultimate cross tested formula treats each participant as a separate allocation group, allowing the sponsor to choose a separate allocation for each participant.

One of the concerns with cross testing is that an error in information (such as incorrect compensation or an incorrect age) can cause a discrimination test failure. To address this I use a failsafe provision which dictates that an additional

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contribution be made until tests are passed or if no additional allocation is made that the allocation of contributions be adjusted until the test is passed. The failsafe is phrased to require the lowest possible reallocations by directing it where it will have maximum impact. The IRS’ position is that a contribution made to correct for a failure to fund the required amount for a participant need not be disclosed to an auditing agent. Thus, in the event of an audit, allocations can be double checked, and corrected if need be, without disclosing this to the agent.

401(k) Funding

If a profit sharing plan has a 401(k) option, participants can defer receipt of compensation and have it contributed to the plan. For employees, this may be their only practical way of saving for retirement. For a business owner it may assist in personnel recruiting and to obtain the maximum allocation for himself while keeping staff cost in line with his budget.

401(k) funding is generally subject to discrimination testing under the ADP (average deferral percentage) test. To pass the ADP test the average deferral by the HCE’s cannot be 2% higher than the average funding for the NHCE’s. With strong NHCE participation testing is viable. If it is low the HCEs’ deferrals may have to be taken back out of the plan, on a timely basis. The other alternative is to make a failsafe allocation to some of the NHCE’s (known as a qualified non-elective contribution, or QNEC).

The alternative to having to pass the ADP test is for the plan to qualify for a safe harbor. There are two safe harbors: (1) the 3% safe harbor and (2) the matching safe harbor. Under the 3% safe harbor the employer agrees to fund 3% each year as a profit sharing allocation for all NHCE’s (without requiring minimum hours to be worked or employment at year end). The 3% that is funded must be 100% vested. Under the matching safe harbor the employer agrees to match employee deferrals up to 4%. The match must also be 100% vested, with no accrual requirements. Whether to use either approach is very situational. A change in employee demographics might dictate a different strategy.

Illustration 8 shows the allocations in a cross-tested 401(k) plan that uses the 3% safe harbor. In this illustration Darryl’s brother, Darryl, was 46 so to pass cross

Do You Have What it Takes to Retire? John H.W. Cole, Esq. Page 10

testing the Darryl’s would have to receive much higher allocations. To avoid this, Larry’s allocation was lowered to 14% and a safe harbor 401(k) feature was added. The safe harbor allocation can be used for cross testing so the overall staff cost was kept down to an affordable amount.

In Service Withdrawals

Once the allocation formula has been determined the next issue is when to permit withdrawals. In theory, a profit sharing plan may permit the withdrawal of allocations that have been held for as little as two years. This is a holdover from 40 years ago when profit sharing plans were simply a vehicle to share profits with employees, not their primary retirement savings vehicle. Today, it does not make sense to permit in service withdrawals at any time since profit sharing plans and 401(k) plans have morphed into the primary vehicle for retirement savings.

A 401(k) plan may permit in service withdrawal of deferrals in 401(k) accounts. This is only permitted for a hardship for which there is an immediate and heavy need. If hardship distributions are permitted I recommend limiting them to the hardships described in the 401(k) regulations, rather than risk an IRS agent second guessing whether a hardship is bona fide. The immediate and heavy need requirement addresses whether the participant could have obtained funds from another source. An immediate and heavy need is presumed if the plan restricts the participant from making deferrals for six months after a hardship withdrawal. It is safer in operation for the plan to have the restriction, but it needs to be remembered in practice.

QDROs

If a qualified domestic relations order (a QDRO) is awarded to the divorcing spouse of a participant (the alternate payee) the alternate payee steps into the participant’s shoes in terms of account ownership. The design choice is whether the alternate payee should be treated as a terminated participant and thus entitled to current payment, or whether the alternate payee must wait until the participant is actually entitled to payment.

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Termination of Employment

Should you pay off participants when they terminate employment or wait until after the close of the plan year? While a plan can select one or the other, to me the answer lies in whether the participant’s interest is physically separated for investment purposes (as is often the case in 401(k) plan) or is pooled with the investments of other participants. If his account is separated it is easy to determine the current balance and pay him what is due when he leaves. If the terminated participant’s interest is pooled, however, you run into the problem of either doing an interim valuation of all accounts, which can be expensive, or making the payment based on the previous year end balance, which may be unfair to other participants in a loss year.

Plan Investment Options.

Life Insurance. Life insurance was a popular plan investment many years ago. Its popularity has decreased in recent years, and its presence in a plan only makes sense if there is a need for life insurance and no other source of payment.

Employer Securities. Purchasing company stock in a plan was also popular many years ago. In the last ten years the IRS has vigorously challenged plans containing stock in the plan sponsor, for various reasons. At the same time the most common source of plan litigation by participants has been “stock drop” cases where employer stock went down in value.

Participant Loans. Participant loans have always been a quick easy source of cash. However, the interest paid on participant loans is not deductible by shareholders or owner participants, which limits the attractiveness of plan loans other than for short term liquidity needs. Experience is probably the ablest indicator of whether the permitting of plan loans is a good idea or a bad idea in a given workplace.

Self-Directed Investments. Employees’ directing their own investments are fairly common in 401(k) plans, even though most employees are not competent to make investment decisions, and would be better off leaving investments decisions to professional money managers. However, if the owners of the plan sponsor are prone to speculative investment, or invest in hard to value (or expensive to value)

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items) such as real estate or limited partnership interests, then self-direction of investments is necessary.

Cash Balance Pension Plans

Defined Benefit Pension Plans base allowable funding on what it takes to provide for an annuity at retirement. Your father’s defined benefit pension plan provided an annual benefit at retirement such as 2% of final average pay times years of service or a lump sum cash out based upon an interest stated in the plan. Congress changed this to require the use of current interest rates for determining the lump sum value of annuities. When interest rates went down from 8% to 4%, the present value of lump sum payouts doubled. Coupled with the reduction in asset values in the great recession, such plans were doomed.

Around 1998 a new type of defined benefit plan appeared. In such plans employees are credited with a hypothetical amount each year, such as 4% of pay, and this becomes their account balance. The lump sum value of an employee’s benefit is his account balance, and doesn’t fluctuate because interest rates go up or down. In addition, earnings are credited to the account each year, based upon a uniform standard, such as the 30 year Treasury Bill rate. If the Treasury Bill rate that year is 3%, then 3% earnings are credited to the account balance. All the sponsor has to do to avoid risk is to earn more than the T-Bill rate, which can be accomplished by investing in short or immediate term bond funds.

Illustration 9 is an example of a cash balance pension and profit sharing plan combination. The amount funded reflects an actual case. Larry started the plan at age 69 and built it up for six years.

Lastly, Illustration 10 shows that considerable funding can be obtained by someone who is only 42. The two plans are combined for purposes of discrimination testing. The testing mathematics work best with Darryl not being in the pension plan, and Larry being the only person in the pension plan reduces reporting requirements and plan administration costs.

Do You Have What it Takes to Retire? John H.W. Cole, Esq. Page 13

Prepared by John H.W. Cole, Esq. 2 2014 VT Bar Assoc. Annual Meeting

Illustration 1-1

After Tax Investment Outside of a Qualified Plan Before Tax Investment Through a Qualified Plan Annual Investment Annual Investment

Annual Amount Available 23,000 Annual Funding 23,000Employer Share of FICA 7.65% (1,634)Compensation 21,366Employee Share of FICA 7.65% (1,634)State Income Tax 6.80% (1,453)Federal Income Tax 25.00% (5,341) Rate of Return 6.0%Annual Addition to Investment Account 12,937Rate of Return 6% Years Invested Before Starting Withdrawals 17Years Invested Before Starting Withdrawals 17Accumulation at Retirement $321,652 Accumulation at Retirement $687,828

Balance + Total Ending Beginning EndingYear Funding Earnings Taxes Balance Year Balance Earnings Balance

2014 12,937 776 (247) 13,466 2014 23,000.00 1,380 24,3802015 26,403 1,584 (504) 27,483 2015 47,380.00 2,843 50,2232016 40,420 2,425 (771) 42,074 2016 73,223.00 4,393 77,6162017 55,011 3,301 (1,049) 57,262 2017 100,616.00 6,037 106,6532018 70,199 4,212 (1,339) 73,072 2018 129,653.00 7,779 137,4322019 86,009 5,161 (1,641) 89,528 2019 160,432.00 9,626 170,0582020 102,465 6,148 (1,955) 106,658 2020 193,058.00 11,583 204,6412021 119,595 7,176 (2,282) 124,489 2021 227,641.00 13,658 241,2992022 137,426 8,246 (2,622) 143,049 2022 264,299.00 15,858 280,1572023 155,986 9,359 (2,976) 162,369 2023 303,157.00 18,189 321,3462024 175,306 10,518 (3,345) 182,479 2024 344,346.00 20,661 365,0072025 195,416 11,725 (3,728) 203,413 2025 388,007.00 23,280 411,2872026 216,350 12,981 (4,128) 225,203 2026 434,287.00 26,057 460,3442027 238,140 14,288 (4,544) 247,884 2027 483,344.00 29,001 512,3452028 260,821 15,649 (4,976) 271,494 2028 535,345.00 32,121 567,4662029 284,431 17,066 (5,426) 296,071 2029 590,466.00 35,428 625,8942030 309,008 18,540 (5,896) 321,652 2030 648,894.00 38,934 687,828

Prepared by John H.W. Cole, Esq. 2 2014 VT Bar Assoc. Annual Meeting

Illustration 1-2

Withdrawals from After Tax Account Withdrawals from a Qualified Plan

Year Withdrawals Start 2031 Year Withdrawals Start 2031Number of Withdrawal Years 25 Number of Withdrawal Years 25Rate of Return 6% Rate of Return 6%State Rate After Retirement 3.55% State Rate After Retirement 3.55%Federal Rate After Retirement 15% Federal Rate After Retirement 15%Total Spendable Income $634,125.96 Total Spendable Income Available For Retirement $1,303,253

Beginning Annual Total Spendable Beginning Annual Annual Total SpendableYear Balance Earnings Tax Income Year Balance Earnings Withdrawal Tax Income

2031 321,652 19,299 (3,580) 13,495 2031 687,828.00 41,270 29,164 (5,410) 23,7542032 323,876 19,433 (3,605) 14,154 2032 699,934.00 41,996 30,914 (5,734) 25,1802033 325,550 19,533 (3,623) 14,846 2033 711,016.00 42,661 32,769 (6,078) 26,6912034 326,613 19,597 (3,635) 15,572 2034 720,908.00 43,254 34,735 (6,443) 28,2922035 327,003 19,620 (3,640) 16,333 2035 729,427.00 43,766 36,819 (6,830) 29,9892036 326,651 19,599 (3,636) 17,131 2036 736,374.00 44,182 39,028 (7,239) 31,7892037 325,484 19,529 (3,623) 17,968 2037 741,528.00 44,492 41,369 (7,674) 33,6952038 323,423 19,405 (3,600) 18,846 2038 744,651.00 44,679 43,852 (8,135) 35,7172039 320,382 19,223 (3,566) 19,767 2039 745,478.00 44,729 46,483 (8,622) 37,8612040 316,272 18,976 (3,520) 20,733 2040 743,724.00 44,623 49,272 (9,140) 40,1322041 310,996 18,660 (3,461) 21,746 2041 739,075.00 44,345 52,228 (9,688) 42,5402042 304,448 18,267 (3,389) 22,809 2042 731,192.00 43,872 55,362 (10,269) 45,0932043 296,517 17,791 (3,300) 23,924 2043 719,702.00 43,182 58,683 (10,885) 47,7982044 287,084 17,225 (3,195) 25,093 2044 704,201.00 42,252 62,204 (11,539) 50,6652045 276,021 16,561 (3,072) 26,319 2045 684,249.00 41,055 65,937 (12,232) 53,7052046 263,191 15,791 (2,929) 27,605 2046 659,367.00 39,562 69,893 (12,965) 56,9282047 248,448 14,907 (2,765) 28,954 2047 629,036.00 37,742 74,086 (13,743) 60,3432048 231,635 13,898 (2,578) 30,369 2048 592,692.00 35,562 78,532 (14,568) 63,9642049 212,586 12,755 (2,366) 31,854 2049 549,722.00 32,983 83,244 (15,442) 67,8022050 191,121 11,467 (2,127) 33,410 2050 499,461.00 29,968 88,238 (16,368) 71,8702051 167,051 10,023 (1,859) 35,043 2051 441,191.00 26,471 93,532 (17,350) 76,1822052 140,172 8,410 (1,560) 36,756 2052 374,130.00 22,448 99,145 (18,392) 80,7532053 110,267 6,616 (1,227) 38,552 2053 297,433.00 17,846 105,093 (19,495) 85,5982054 77,104 4,626 (858) 40,436 2054 210,186.00 12,611 111,399 (20,665) 90,7342055 40,436 2,426 (450) 42,412 2055 111,398.00 6,684 118,082 (21,904) 96,178

Prepared by John H.W. Cole, Esq. 2 2014 VT Bar Assoc. Annual Meeting

Illustration 2-1

After Tax Investment Outside of a Qualified Plan Before Tax Investment Through a Qualified Plan Annual Investment Annual Investment

Annual Amount Available 52,000 Annual Funding 52,000Employer Share of FICA 1.45% (743)Compensation @ 51,257Employee Share of FICA 1.45% (743)State Income Tax 8.80% (4,511)Federal Income Tax 33.00% (16,915) Rate of Return 6.0%Earned Income Surtax 0.90% 461Annual Addition to Investment Account 29,088Unearned Income Surtax @ 3.80%Rate of Return 6% Years Invested Before Starting Withdrawals 17Years Invested Before Starting Withdrawals 17Accumulation at Retirement $668,449 Accumulation at Retirement $1,555,094

Balance + Total Ending Beginning EndingYear Funding Earnings Taxes Balance Year Balance Earnings Balance

2014 29,088 1,745 (796) 30,037 2014 52,000.00 3,120 55,1202015 59,125 3,548 (1,618) 61,055 2015 107,120.00 6,427 113,5472016 90,143 5,409 (2,467) 93,085 2016 165,547.00 9,933 175,4802017 122,173 7,330 (3,343) 126,161 2017 227,480.00 13,649 241,1292018 155,249 9,315 (4,248) 160,316 2018 293,129.00 17,588 310,7172019 189,404 11,364 (5,182) 195,587 2019 362,717.00 21,763 384,4802020 224,675 13,481 (6,147) 232,008 2020 436,480.00 26,189 462,6692021 261,096 15,666 (7,144) 269,618 2021 514,669.00 30,880 545,5492022 298,706 17,922 (8,172) 308,457 2022 597,549.00 35,853 633,4022023 337,545 20,253 (9,235) 348,563 2023 685,402.00 41,124 726,5262024 377,651 22,659 (10,332) 389,978 2024 778,526.00 46,712 825,2382025 419,066 25,144 (11,466) 432,744 2025 877,238.00 52,634 929,8722026 461,832 27,710 (12,635) 476,907 2026 981,872.00 58,912 1,040,7842027 505,995 30,360 (13,845) 522,510 2027 1,092,784.00 65,567 1,158,3512028 551,598 33,096 (15,092) 569,602 2028 1,210,351.00 72,621 1,282,9722029 598,690 35,921 (16,380) 618,232 2029 1,334,972.00 80,098 1,415,0702030 647,320 38,839 (17,711) 668,449 2030 1,467,070.00 88,024 1,555,094

Prepared by John H.W. Cole, Esq. 2 2014 VT Bar Assoc. Annual Meeting

Illustration 2-2

Withdrawals from After Tax Account Withdrawals from a Qualified Plan

Year Withdrawals Start 2031 Year Withdrawals Start 2031Number of Withdrawal Years 25 Number of Withdrawal Years 25Rate of Return 6% Rate of Return 6%State Rate After Retirement 7.80% State Rate After Retirement 7.80%Federal Rate After Retirement 28% Federal Rate After Retirement 28%Unearned Income Tax Rate 3.80% Unearned Income Tax Rate n/a Total Spendable Income 1,097,158 Total Spendable Income Available For Retirement $2,322,464

Beginning Annual Total Spendable Beginning Annual Annual Total SpendableYear Balance Earnings Tax Income Year Balance Earnings Withdrawal Tax Income

2031 668,449 40,106.94 (15,882) 27,707 2031 1,555,094.00 93,306 65,936 (23,605) 42,3312032 664,967 39,898.00 (15,800) 28,711 2032 1,582,464.00 94,948 69,892 (25,022) 44,8702033 660,354 39,621.24 (15,690) 29,752 2033 1,607,520.00 96,451 74,086 (26,523) 47,5632034 654,534 39,272.02 (15,552) 30,830 2034 1,629,885.00 97,793 78,531 (28,114) 50,4172035 647,424 38,845.46 (15,383) 31,947 2035 1,649,147.00 98,949 83,243 (29,801) 53,4422036 638,940 38,336.40 (15,181) 33,105 2036 1,664,853.00 99,891 88,237 (31,588) 56,6492037 628,990 37,739.42 (14,945) 34,304 2037 1,676,507.00 100,590 93,531 (33,484) 60,0472038 617,480 37,048.83 (14,671) 35,548 2038 1,683,566.00 101,014 99,143 (35,493) 63,6502039 604,310 36,258.62 (14,358) 36,836 2039 1,685,437.00 101,126 105,092 (37,623) 67,4692040 589,375 35,362.48 (14,004) 38,171 2040 1,681,471.00 100,888 111,397 (39,880) 71,5172041 572,563 34,353.76 (13,604) 39,554 2041 1,670,962.00 100,258 118,081 (42,273) 75,8082042 553,758 33,225.49 (13,157) 40,988 2042 1,653,139.00 99,188 125,166 (44,809) 80,3572043 532,839 31,970.33 (12,660) 42,473 2043 1,627,161.00 97,630 132,676 (47,498) 85,1782044 509,676 30,580.55 (12,110) 44,012 2044 1,592,115.00 95,527 140,637 (50,348) 90,2892045 484,134 29,048.06 (11,503) 45,607 2045 1,547,005.00 92,820 149,075 (53,369) 95,7062046 456,072 27,364.33 (10,836) 47,260 2046 1,490,750.00 89,445 158,020 (56,572) 101,4482047 425,340 25,520.41 (10,106) 48,973 2047 1,422,175.00 85,331 167,501 (59,965) 107,5362048 391,782 23,506.91 (9,309) 50,747 2048 1,340,005.00 80,400 177,551 (63,563) 113,9882049 355,232 21,313.95 (8,440) 52,587 2049 1,242,854.00 74,571 188,204 (67,377) 120,8272050 315,520 18,931.17 (7,497) 54,492 2050 1,129,221.00 67,753 199,496 (71,420) 128,0762051 272,462 16,347.70 (6,474) 56,467 2051 997,478.00 59,849 211,465 (75,704) 135,7612052 225,868 13,552.11 (5,367) 58,513 2052 845,862.00 50,752 224,154 (80,247) 143,9072053 175,540 10,532.43 (4,171) 60,634 2053 672,460.00 40,348 237,603 (85,062) 152,5412054 121,268 7,276.08 (2,881) 62,831 2054 475,205.00 28,512 251,859 (90,166) 161,6932055 62,831 3,769.88 (1,493) 65,108 2055 251,858.00 15,111 266,969 (95,575) 171,394

Illustration 3

John HW Cole, Esq, 2014 VT Bar Assoc. Annual Meeting

Illustration 4

Larry The Lawyer, P.C. Pro Rata FormulaProfit Sharing Plan

Plan Year Begins: 01/01/2014

Total Compensation 153,000.00Individual Compensation Limit 245,000.0025% Deduction Limit 38,250.00Total Funding $38,250.00Allocation Rate 25%

HCE Allocation 24,500.00NHCE Allocation 13,750.00NHCE Share of Allocation 35.95%

Name Status Age Compensation Allocation

Larry HCE 63 98,000.00 24,500.00Darryl NHCE 27 35,000.00 8,750.00His brother Darryl NHCE 33 20,000.00 5,000.00

John HW Cole, Esq. 2014 VT Bar Assoc. Annual Meeting

Illustration 5: Integrated Formula

Larry The Lawyer, P.C. Profit Sharing PlanPlan Year Begins: 01/01/2014

Total Compensation Funding 24.78%Excess Compensation Funding 5.40%Excess Compensation Level (80% of taxable wage base) 93,600Deduction Limit (25% of total compensation) 38,750

Total Funding 38,750

Excess Base Excess TotalName Status Age Compensation Pay Allocation Allocation Allocation

Larry HCE 63 100,000 6,400.00 24,777 346 25,123Darryl NHCE 27 35,000 8,672 8,672His brother Darryl NHCE 33 20,000 4,955 4,955

John HW Cole, Esq. 1 2014 VT Bar Assoc. Annual Meeting

Illustration 6-1 Age Weighted Formula

Larry the Lawyer P.C. Profit Sharing Plan

Normal Retirement Age 65Funding Factor 0.440377Deduction Limit 38,750.00

Years Assigned Total PercentParticipant Status Compensation Age to 65 Factor Funding Of Pay

Larry HCE 100,000.00 63 2 0.84946 37,408.26 37.41%Darryl NHCE 35,000.00 27 38 0.04505 694.36 1.98%His brother Darryl NHCE 20,000.00 33 32 0.07350 647.35 3.24%

155,000.00 38,749.97

John HW Cole, Esq. 2 2014 VT Bar Assoc. Annual Meeting

Illustration 6-2 Rate Group TestLarry the Lawyer P.C. Profit Sharing Plan

Number of NHCE's 2Number of Participants 1NHCE Concentration 66.67%Required Ratio Percentage 40.50%Lowest Ratio Percentage 100.00%Test Result PASSED

Projected Projected Accrual HCE NHCEParticipant Allocation Factor Accumulation Benefit Rate Accruals Accruals

Larry HCE 37,408.26 1.17723 44,038.13 4,246.89 0.0425 0.0425Darryl NHCE 694.36 22.19883 15,413.98 1,486.47 0.0425 0.0425The Other Darryl NHCE 647.35 13.60666 8,808.27 849.44 0.0425 0.0425

John HW Cole, Esq. 2014 VT Bar Assoc. Annual Meeting

Illustration 7 Cross Tested Formula

Larry The Lawyer, P.C. Profit Sharing Plan

Plan Year Begins: 01/01/2013

Total Pay 155,000.00Individual Compensation Limit 255,000.00Deduction Limit 38,750.00

Normal Retirement Age 65

Rate Group Test: PASSEDAverage Benefit Test PASSED

Testing Plan 415 Assigned TotalParticipant Status Age Comp LIMIT Rate Funding

Larry HCE 63 100,000.00 100,000.00 0.36000 36,000.00Darryl NHCE 50 35,000.00 5,500.00 0.05000 1,750.00His brother Darryl NHCE 27 20,000.00 5,500.00 0.05000 1,000.00

John HW Cole, Esq. 2014 VT Bar Assoc. Annual Meeting

Illustration 8 Safe Harbor Profit SharingLarry The Lawyer, P.C. 401(k) Plan

Plan Year Begins: 01/01/2014 Staff Cost: 3,304.08Percent of Employer Cost: 8.41%

3% Safe P/S Profit Total Participant Status Compensation Age Harbor Deferral Catchup Rate Sharing Funding

Larry HCE 100,000.00 63 16,500.00 5,500.00 0.1400 14,000.00 36,000.00Darryl NHCE 35,000.00 58 1,494.62 0.0467 139.88 1,634.50His brother Darryl NHCE 20,000.00 46 1,669.58 0.0467 1,669.58

39,304.08

John HW Cole, Esq. 2014 VT Bar Assoc. Annual Meeting

Illustration 9

Larry's Pension & Profit Sharing Plans Staff Cost: 11,518.50 Total Cost: 273,418.50 Percentage: 4.21%

Pension Credited P/S Profit TotalParticipant Compensation Age Status Rate Pension Rate Sharing Benefit

Larry 240,000.00 75 HCE 110% 264,000.00 1.90% 4,554.00 264,000.00Darryl 72,000.00 40 NHCE 2% 1,440.00 6.97% 5,018.40 6,458.40His brother Darryl 33,000.00 24 NHCE 2% 660.00 6.97% 2,300.10 2,960.10Total 345,000.00 266,100.00 11,872.50 273,418.50

John HW Cole, Esq. 2014 VT Bar Assoc. Annual Meeting

Illustration 10Larry The Lawyer, P.C. Pension and Profit Sharing Plan

Plan Year Beginning 01/01/2014Normal Retirement Age 62 6% Profit Sharing Limit: 13,560.00

Name of Att Pension Credited 401(k) P/S Profit TotalParticipant Plan Pay Age Rate Pension Deferral Rate Sharing Benefit

Larry 206,000.00 42 45.60% 93,936.00 17,000.00 0.0580 11,948.00 122,884.00Darryl 20,000.00 25 0.0750 1,500.00 1,500.00Totals: 226,000.00 93,936.00 17,000.00 13,448.00 124,384.00