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Law and Disorder: Rethinking Retirement Planning for Plaintiff’s Lawyers – The Best of Qualified and Non-qualified Planning Solutions


We have all heard our share of lawyer jokes. From War of the Roses – “What do you call a bunch of attorneys at the bottom of the ocean”? Answer – A good start!  Everybody hates lawyers except their own and the “piranha” that represented your “Ex”.

As far as commercial welfare is concerned, these are not the best of times for trial lawyers. Personal injury attorneys tell me that insurance companies have been dragging their feet to settle while lawyers representing the insurance company seem to be working for minimum wage. Nobody is happy! However, tomorrow is another day and the next big case is right around the corner.

When that day arrives and a large settlement for the trial attorney is aligned in the trigger hairs, here is a combination of planning techniques to consider in order to maximize retirement planning for the trial attorney.

When the “Good Ship Lollipop” in port, you need to know where and how to get on.

Qualified Retirement Plan Considerations for the Attorney

It is my contention that every business owner would like to have a defined benefit retirement plan providing the business owner does not have to contribute to  the plan for his employees. Qualified retirement plans remain as one of the best tax planning options to reduce corporate and personal income. In the realm of qualified retirement plan considerations, the defined benefit (DB) plan is the option that allows for the largest contribution and benefit. The maximum retirement benefit, under a DB plan in 2013 is $205,000 with maximum compensation of $255,000 being considered. The largest defined  contribution plan contribution is $51,000 in 2013.  Contribution levels can exceed the defined contribution limit by multiples.

In general DB Plans come in two versions – fully insured and traditional. The fully insured DB plan is funded exclusively with annuities and life insurance. The combination of annuities and life insurance produces the largest tax deductible contribution into the plan in most case. At retirement (absent a lump sum payment and rollover to an IRA), the retirement annuity benefits are contractually guaranteed by the life insurer that issued the annuity contracts and life insurance.

Life insurance within the Plan provides pre-retirement death benefit. A guaranteed and fixed retirement benefit is not such a bad thing as the foundation of your retirement income when you consider the multiple precipitous stock market declines over the last thirty years. Similarly, unlike Detroit’s pension plan and those of many states and municipalities that are horrendously underfunded, the fully insured defined benefit plan can never be underfunded.

Regardless of the countless benefits in favor of  fully insured benefit plans, investment advisors who may have a bias against insurance-based solutions from an investment standpoint, may recommend a traditional DB plan or a split funded plan that is funded with investments and insurance. The maximum retirement benefit under the plan is $205,000.

The split funded defined benefit plan is comprised of an investment account along with life insurance to fund a pre and post retirement death benefit for the participant’s beneficiary. The Plan may also include a provision for a disability benefit and a medical account to fund post retirement medical costs.

Did I Tell You that You Do (Not) Need to Contribute for Your Employees!

Congress has passed any number of tax rules designed to prevent business owners from discriminating against their employees in the adoption of pension plans. Part of these rules are the controlled group rules of IRC Sec 414(b) and (c) and affiliated service group rules of IRC Sec 414(m). These rules are designed to prevent the business owner from circumventing the discrimination and participation rules through the creation of multiple entities with fewer or no employees to avoid pension contributions for the employees.

The affiliated service group rules are set up for service businesses such as health, law, accounting, dentistry, engineering, architecture et al. The material determination whether or not a business is a “service business” for purposes of the rules is whether or not capital is a material factor in the production of income. In the case of law, there is no legal uncertainty, it is a service business subject to the affiliated service group rules. The consequence of the affiliated service group rules is treat to aggregate all of the employees into a single group for benefits purposes.

An affiliated service group refers to a related group of employers made up of two or more organizations that both a service and ownership relationship. An affiliated service group falls into three categories – (1) A-Organization Group (A-Org) – Consists of at least one A-Org and a First Service Organization (FSO)  (2) B-Organization Group (B-Org) and (3) Management Group. A FSO must be a service organization (incorporated or unincorporated) who principal business is the performance of services (such as law) as defined in IRC Sec 414(m)(3).

Clear as mud? An A-Org must meet two tests – (1) Ownership Test – An A-Org must have an ownership interest in the FSO. The attribution rules under IRC Sec 318(a) are applicable and (2) The A-Org must regularly perform services for the FSO or is regularly associated with the FSO in the performance of services for third parties.

A “B-Org” meets the following requirements – (1) It performs all of its services for a FSO or A-Org determined with respect to a FSO or both (2) The services must be of a type historically performed by employees in the service field of the FSO or A-Org and (3) 10 percent or more of the organization must be held by highly compensated employees in the aggregate who are highly compensated employees of the FSO or A-Org.

What does this look like in the context of a law firm?  Attorney Smith is the 100 percent shareholder of Smith, PC. Attorney Jones is the 100 percent shareholder of Jones PC. Smith PC owns 50 percent of Smith-Jones Attorneys, LLC as does Jones PC. Smith-Jones, LLC employees six legal secretaries and paralegal s.

In this example, Smith-Jones is a FSO that is regularly associated with performance of services for third parties. Both Smith, PC and Jones PC are members of Smith-Jones, LLC, a FSO (First Service Organization). Smith, PC and Jones, PC are both A-Orgs. Both professional corporations regularly perform services for the FSO, Smith-Jones and is regularly associated with the performance of services with the FSO for third parties. It is an affiliated service group. All of the employees will be aggregated as a single employer for benefits purposes.

The affiliated service group rules are highly restrictive and very complex and difficult to circumvent. importantly, IRC Sec 410(b)(3)(A) provides an important exemption that allows the law firm to exclude the firm’s employees from participation in the firm’s pension plan. This Code section exempts employees that are covered for retirement as well as employee benefits under a collectively bargained agreement that is the result of good faith negotiations with a bona fide labor union.

A qualified defined benefit plan under IRC Sec 401(a)(26) must benefit at least the lesser of (1) At least 50 employees of the Employer or (2) The greater of 40 percent of employees or two employees (or if there is one employee, such employee. IRC Sec 410(b)(3)(A) provides for the legal exclusion from participation in the Plan.

Structured Settlement Annuities and Qualified Settlement Funds (QSF) – A Non-Qualified Pension Arrangement for Trial Attorneys

In Childs v. Commissioner, 103 T.C. 634 (1994), aff’d 89F3d 856 (11th Cir 1996), the Tax Court ruled in favor of an attorney fee deferral arrangement. This decision was the first and only case supporting the right of an attorney to defer contingency fee income. The Court ruled that the attorney did not have constructive receipt of the attorney’s fees because the attorney did not have any right to a fee until the settlement agreement was signed.

Federal tax legislation introduced IRC Sec 409A to the Internal Revenue Code in 2004. This tax legislation deals with the requirements for deferred compensation arrangements. The Treasury Department issued its “Guidance on Deferred Compensation” on December 21, 2004. The FAQ Section of the IRS notice provides that the limitations of IRC Sec 409A do not extend to attorney fee deferral arrangements.

Regardless of the favorable ruling, the structured settlement annuity for trial attorneys that elect to defer all of part of their contingency fee income, has not been robust compared to the market for plaintiffs. In my view, there are several reasons for this- (1) The unattractive investment return and lack of investment flexibility in fixed annuities used in the structured settlement annuity market. (2) The inability to structure contingency in non-qualified (non-personal injury or medical malpractice) cases. (3) The absence of better product and tax planning options. I have previously rather extensively on the use of private placement insurance products

QSFs are trusts that are designed to resolve litigation and satisfy claims of the litigation even if they are not the subject of litigation. The QSF is authorized and governed by the provisions of IRC Sec 468B. A QSF has no statutory time limit within IRC Sec 468B or the treasury regulations in regard to how long a QSF may be kept in place.

The QSF has benefits for both plaintiffs and defendants. From a defendant’s perspective, the ability to transfer assets to a QSF can resolve the claim and release the defendant from further liability while achieving an immediate tax deduction regardless of when claimants actually receive distributions. This is a significant tax planning point for the defendant particularly for non-physical injury tort cases.

The plaintiff is able to achieve numerous benefits. Claimants can use the QSF to time the receipt of their income. Plaintiffs are not taxed until they actually receive distributions from the QSF. The QSF provides the plaintiff and their attorney with the ability to work out the details of their distribution.

Structured settlement annuities provide an important form of non-qualified deferred compensation plan. Effectively, the ability for trial attorneys to defer contingency fee income is an IRA or qualified retirement plan without a limit.

I am suggesting that a law firm or trial lawyer coordinate these plan elements into a single integrated and cohesive retirement planning strategy combining the benefits of qualified arrangements (defined benefit, 401(k) and profit sharing) and non-qualified (structured settlement annuity).

Strategy Example

Bob Jones, age 50, is a solo practioner with five employees. Bob has a trial practice including personal injury  and medical practice. Bob routinely  settles medical malpractice cases.  In a good year, his income can double to $1 million or more. In a bad year, his income can be $255,000. His typical compensation is $400,000-500,000.

John has had a late start in his retirement planning and would like to make up for lost time.  With his children’s college expenses behind him and his house paid for, he determines that he must make his retirement his financial priority. John has a half dozen medical practice cases in various stages of trial preparation along with a solid inventory of personal injury cases.

He decides to have his employees covered under a union plan. He forms a split funded defined benefit plan along with a 401(k) and profit sharing plan which allow for flexible contributions.  John’s retirement goal is an income of $410,000.

The defined benefit plan provides for retirement at age 62 and will provide him with a projected retirement benefit of $205,000 per year.  The additional goal will be made up from payments in a non-qualified retirement plan created through the deferral of contingency fees. The pension actuary will create the funding assumptions for the non-qualified component of the plan.

The plan is loaded with ancillary benefits – (1) 100 percent joint and survivor retirement benefit so that Mrs. Jones does not experience any reduction in benefits upon John’s death (2) Pre and post retirement death benefits equal to 100 percent of the monthly retirement benefit.(3) Disability benefits  (4) Post retirement medical and long term care benefits.

In 2013, John expects to settle a medical malpractice income  receives contingency fee income of $1 million so that his total income is  expected to be $1,500,000. John expects able to make a tax deductible contribution of $465,000. He makes a 401(k) contribution of $23,000 as well. His profit sharing contribution is $15,300. The total contribution of $465,000 to his defined benefit plan,  the maximum contribution, to fund his target retirement benefit of $205,000 per year at age 62.

The funding pattern for the DB plan has some flexibility. If John has a bad income year in 2014, he can make a minimum contribution of $24,000 in to the defined benefit plan. The recommended annual contribution is $170,000. The total projected contribution in 2013 is $503,000. He has the option of adding Mrs. Jones as a participant if he desires to increase the level of contribution into the Plan beyond the $503,000 cumulative contribution for John’s account.

John’s engagement agreement with his legal  client has John agreeing to defer receipt of his  of one-half of his contingency fee of $1.5 million – $750,000. The funding target under the non-qualified portion of the defined benefit plan has the pension actuary targeting an amount of approximately $2.7 million at normal retirement age under both plans in order to provide a non-qualified benefit of $205,000 per year on a joint and survivor basis for the lifetime of John and Mrs. Jones.  The total retirement benefit under both the qualified and non-qualified plans is $410,000 per year.

Even if John decides not to utilize the union exemption under IRC Sec 410(b)(3)(A), a combination of plans and cross testing should allow John to receive in excess of 95 percent of the qualified plan contributions.


The article is designed to make you think about a few things. First, defined benefit plans are the retirement dream of business owners and professional. But for having to contribute for employees, every business owner would have a defined benefit plan in his business. Second, most business owners are unaware of the exemption to exclude workers under IRC Sec 410(b)(3)(A). Third, even if you don’t utilize this exemption, there are a number of plan techniques such as multiple plans and cross testing to skew benefits and contributions in favor of the business owner.

Fourth, defined benefit plan design has the potential to dramatically increase the level of the tax deductible contribution into the Plan. Fifth, the tax rules regarding defined benefit plans now provide for a range of contribution levels to accommodate a bad year. Lastly and most importantly, the trial attorney should be integrating his qualified plan planning together with the non-qualified deferral of contingency fee income towards a singular retirement goal.

The ability of the trial attorney to defer contingency fee income is effectively an IRA or plan without a contribution cap. Use it or lose it!