105-1 Qualified Plan Requirements & Regulatory Plan Considerations

Question 1

Internal Revenue Service (IRS)

Answer 1

Carries out the administrative duties of the qualified plan system (and, to a lesser extent, the non-q plan system) by:
A) supervising creation of new retirement plans and monitoring and auditing the operation of existing plans
B) interpreting federal legislation, especially w/ regard to the tax consequences of certain plan designs
C) administering the qualified plan system

Question 2

Employee Retirement Income Security Act of 1974 (ERISA)

Answer 2

Federal law that governs the non-tax aspects of private retirement plans and other employee benefits such as health and welfare plans

Qualified plans must meet ERISA requirements:

• coverage
• participation
• vesting
• reporting and disclosure
• fiduciary requirements

Question 3

Department of Labor (DOL)

Answer 3

Ensures compliance with ERISA’s plan reporting and disclosure rules and oversees compliance w/ the prohibited transaction rules

Issues prohibited transaction exemptions (PTEs)

Question 4

Pension Benefit Guaranty Corporation (PBGC)

Answer 4

Created under ERISA
Responsible for insuring plan participants against loss of benefits from plan termination

PBGC can terminated a defined benefti plan if:

• minimum funding standards are not met
• benefits can’t be paid when due
• the long-run liability of the company to the PBGC is expected to increase unreasonably

Question 5

3 General Categories of Retirement Plans

Answer 5

1. Qualified Plans
2. Tax-Advantaged Plans
3. Non-Qualified Plans

Question 6

Mandatory vs non-mandatory contributions

Answer 6

Mandatory annual contributions means plan is a pension plan

Non-mandatory contributions means plan is a profit-sharing plan

Defined benefit plan = pension plans
Defined contribution plans = either pension plan or profit-sharing plan

Question 7

Qualified Plans

Answer 7

Retirement plans that meet a # of requirements

In return for meeting the requirements, the employer-sponsor of the plan is afforded a major tax advantage, namely, the immediate deductibility of all contributions made to the plan

Question 8

Tax-advantaged plan

Answer 8

Does not meet all of the requirements to be classified as a qualified plan but often operates very similarly to a qualified plan w/ tax-deferred earnings and perhaps pretax (or tax-deductible) contributions

Question 9

Nonqualified plans

Answer 9

One advantage: they do not have to meet the nondiscrimination requirements of qualified plans

Merely a promise by the employer to pay the employee benefits

Question 10

Qualified Plan Eligibility

Answer 10

Any employee who has attained age of 21 and 1 year of service must be permitted to enter the plan within 6 months

Year of service means a 12-month period during which the employee has worked at least 1,000 hrs

As an alternative to the 21-and-1 rule, the waiting period to enter the plan may be increased to 2 years of service

Most plans adopt 2 entrance dates: Jan 1 and July 1

Question 11

Highly compensated employee (HCE)

Answer 11

An employee who meets 1 of the following criteria:

1. Was a > 5% owner of the employer at any time during the current year or preceding year
2. For the preceding year, had compensation greater than $125k (2019) from the employer

Question 12

Percentage Test

Answer 12

Applies to qualified plans
Section 410(b) of the Tax Code requires the employer-sponsor of the qualified plan must cover at least 70% of the nonhighly compensated employees

Covered means employee is benefiting under the plan

Question 13

Active participation

Answer 13

Employee must be contributing to the plan, having employer contributions or forfeitures allocated on his behalf, or accruing a benefit in a defined benefit plan before he is considered an active participant in a qualified plan for IRA purposes

Question 14

Plans that do not meet the % test must satisfy either (to be a qualified plan):

Answer 14

1. ratio test: the % of non-HCE’s covered by the plan must be at least 70% of the % of HCEs who are covered
2. average benefits % test: the avg benefits % accrued for non-HCEs as a group must be greater than or equal to 70% of the avg benefits % accrued for the HCEs

Question 15

Qualified plan discrimination rules

Answer 15

Qualified plan may discriminate against HCEs without risking plan disqualification, but it may not discriminate in favor of HCEs
If the employer wishes to discriminate in favor of an HCE (typically an executive or officer of the corporation), it may implement a non-q plan

Question 16

50/40 Test

Answer 16

Defined benefit pension plans must meet the 50/40 test

Mandates that all defined benefit pension plans must benefit no fewer than the lesser of:

• 50 employees
• 40% of all eligible employees

Remember “people before percentages” (50 people of 40%)

Question 17

Controlled Group Rules

Answer 17

Designed to prevent discrimination against nonhighly compensated employees

Question 18

Cap on covered compensation within qualified plans

Answer 18

To prevent a qualified plan from being used primarily as a tax shelter for highly compensated employees and executives, the Tax Code imposes a limitation on plan benefits and contributions

2019 cap on covered compensation: $280k annually
Only the first $280k of any participant’s compensation may be used to determine contributions for a qualified plan

Question 19

Defined benefit pension plans

Answer 19

The benefit paid at normal retirement age, as specified in the plan documents (usually age 65 or the Social Security normal retirement age), cannot exceed the lesser of:

1. 100% of participant’s compensation averaged over the 3 highest consecutive years of compensation, w/ covered compensation considered in the avg being limited to $280k (2019); or
2. $225k annually (2019)

Question 20

Defined contribution plans annual additions limit

Answer 20

Cannot exceed lesser of:

1. 100% of participant’s annual compensation
2. $56,000 annually (2019)

Annual additions include:

1. Employer contributions
2. Employee contributions (both pretax and after-tax contributions)
3. Forfeitures allocated to the defined contribution plan on behalf of the employee

Forfeitures are nonvested amounts returned to the plan when a participant separates from service without being 100% vested

Question 21

Contributory plan

Answer 21

Employer makes some contributions

Question 22

Noncontributory plan

Answer 22

Employer pays all

Most pension and profit-sharing plans are noncontributory

Most qualified plans are noncontributory because employers and employees view them as part of an overall compensation package paid for by the employer

Question 23

Vesting

Answer 23

Occurs when an employee’s nonforfeiture right to receive a present or future retirement plan benefit is accrued over time per the schedule identified in the employee-sponsored retirement plan

“Years of service” schedule begins with an employee’s hire date, not the employee’s entrance into the plan

Question 24

Non-top-heavy

Answer 24

Defined benefit pension plan must vest at least as rapidly as one of the following 2 schedules:
1. 5-yr 100% or cliff vesting: in this schedule, no vesting is required before 5 years of employee service, with 100% vesting then required at the end of 5 years of service

2. 3-7 year graduated or graded vesting: Using this schedule, the plan must provide vesting that is at least as fast as those listed in the following table

Question 25

Key Employee

Answer 25

For purposes of the top-heavy rules is an employee who, at any time during the plan year, is:

1. an officer of the employer having annual compensation from the employer of more than $180k (2019)
2. a greater than 5% owner of the employer
3. a greater than 1% owner of the employer having annual compensation from the employer of greater than $150,000 (not indexed for inflation)

For these purposes, no more than 50 employees (or, if lesser, the greater of 3 of 10% of the employees) will be treated as officers

Question 26

Top heavy

Answer 26

Defined benefit plan that provides more than 60% of its aggregate benefits or account balances to key employees
2 consequences:
1) Must provide accelerated 3-year cliff or 2-to-6-year graded vesting
2) Must provide a minimum benefit accrual of 2% times the # of yrs of service up to 20% for all non-key employees

Under top-heavy defined contribution plan, the employer must make a minimum contribution of at least 3% of annual compensation to each non-key employee’s account

Question 27

Social Security Integration

Answer 27

aka Permitted Disparity Rules

Integrated plan accounts for the disproportionate benefit accrual under Social Security and provides for a tiered benefit formula, providing a base benefit for compensation up to an integration level, which is typically the Social Security taxable wage base of $132,900 (2019)

Integration can enhance an owner’s and/or key employees’ contribution rate if the compensation is in excess of the Social Security wage base.

Question 28

2 Methods of integrating defined benefit formulas w/ Social Security

Answer 28

1. The excess method (the more common): the plan defines a level of compensation (referred to as the integration level) and then provides a higher rate of contributions and benefits for compensation above this level
2. The offset method: formula approximates the existence of Social Security benefits and reduces the plan formula

Question 29

Integration of Defined Contribution Plans

Answer 29

Defined contribution plans can only be integrated w/ Social Security using an excess method of integration; the offset method is not permitted

Under the permitted disparity rules applying to integration of defined contribution plans, the max allowable excess % is the lesser of:

1. 2x the base %
2. the base % plus 5.7%

Plans prohibited from integration w/ Social Security include:

• employee stock ownership plans (ESOP)
• SARSEP
• SIMPLE plans

Question 30

Advance determination letter

Answer 30

Some employers apply to the IRS for a favorable ruling that the plan provisions meet the Tax Code requirements

Issued by the District Director of the IRS district in which the employer is located

Question 31

Department of Labor, Fiduciary

Answer 31

DOL regulates the actions of qualified plan fiduciaries

ERISA specifies that any investment adviser who renders investment advice for a fee is also a fiduciary

Fiduciaries include the plan sponsor, administrator, investment manager, investment adviser, and the owner who selects the fiduciaries

Question 32

Party in Interest

Answer 32

Broader than the term fiduciary, a party in interest does include a fiduciary and an IA providing advice to plan participants

Question 33

Definitely Determinable Benefits

Answer 33

Defined benefit plans provide definitely determinable benefits by being obligated to pay retirement benefits according to the details promised in the retirement plan document

Defined contribution plans definitely determinable benefits by defining what contributions the employer will make to the plan

Question 34

Summary Plan Description (SPD)

Answer 34

Must be provided automatically to all plan participants within 120 days after the plan is established or 90 days after a new participants enters an existing plan

Question 35

Annual Report (Form 5500 series)

Answer 35

Must be filed w/ the IRS annually by the end of the 7th month after the plan year ends
Also required to be filed with the DOL

Question 36

Summary Annual Report (SAR)

Answer 36

Summarizing the basic info included in the Form 5500 series

Question 37

Individual accrued benefit statement

Answer 37

Must generally be provided to a plan participant within 30 days of the request

Question 38

Summary of material modification (SMM)

Answer 38

Explaining any substantive changes that occurred to the SPD within the past year must be issued as needed

Question 39

Employer contributions to a defined contribution plan

Answer 39

Must vest at least as rapidly as a 3-year cliff vesting schedule, or a 2-to-6 year graded vesting schedule

Question 40

Section 403(b) Plan

Answer 40

A tax-advantaged plan but not an ERISA qualified retirement plan. While tax advantaged plans are very similar to qualified plans, there are some minor differences. For example, a tax advantaged plan is not allowed to have NUA treatment.

Question 41

Organizations that provide pension plan services

Answer 41

1. trust companies
2. commercial banks
3. investment firms
4. asset management groups
5. insurance companies.