2. Qualified Retirement Plans

Question 1

Qualified Plans

Answer 1

Defined Contribution plans:
-Profit-Sharing Plan (not pension plan/not subject to Minimum Funding)
-Money Purchase Plan (employer contribution)
-Target Benefit Plan (employer contribution)

Cash Balance Plan (guaranteed benefit)
Defined Benefit Plan (guaranteed benefit)

Question 2

Tax advantaged plans

Answer 2

SEP-IRA, SIMPLE-IRA, 403(b) plan, and 457 plans

Question 3

Qualified plan rules

Answer 3

• age and service or waiting period requirements: can’t require >1yr (at least 1,000 hrs), any employee 21+, waiting period can be up to 2 yrs if immediately vested (not 401k), no max age
• overall coverage and participation: The Safe Harbor Test (covers at least 70% of all eligible non-highly compensated), Ratio Percentage Test, Average Benefits Test (if ave benefit by non-highly compd is at least 70% of ave benefit by highly compd)

Question 4

Highly Compensated Employees

Answer 4

->5%, owner or family of >5%owner, or Received compensation for the preceding year in > $150,000/top 20%

Question 5

Safe Harbor Test

Answer 5

at least 70% of eligible non-highly compensated employees are covered under the qualified plan, must also pass 50/40: defined benefit plan to cover the lesser of 50 employees or 40% or more of all eligible employees.

Question 6

Angio Corporation produces and sells equipment to hospitals and doctors for use during heart surgeries. Angio employs 12 salespeople and 26 office staff. All these individuals have been with the company for more than one year and are over age 21.

Angio does not want the qualified plan to cover the sales staff. Eleven of the twelve salespeople are highly compensated and six of the office staff are highly compensated.

Will the plan pass the Safe Harbor Test?

Answer 6

If a total of 17 of the employees are highly compensated, then 21 are non-highly compensated. Therefore, the plan would need to cover at least 15 non-highly compensated employees to pass (21 x 0.70 = 14.7). It will cover 20 non-highly compensated employees who work in the office and, therefore, passes the Safe Harbor Test.

Question 7

Average Benefit Test

Answer 7

must benefit a nondiscriminatory classification of employees: total average benefit for all non-highly compensated employees must be at least 70% of the average benefit for highly compensated employees

Question 8

integrating qualified plans benefit formulas with Social Security

Answer 8

The excess method (defined contribution only), and
The offset method

Question 9

Nondiscrimination in Benefits and Contributions

Answer 9

nondiscriminatory with respect to highly compensated employees either in terms of benefits or employer contributions to the plan

Question 10

Permitted disparity

Answer 10

difference in permitted contributions/benefits between those provided to higher-paid employees whose compensation is greater than an amount based on Social Security taxable wage base

Question 11

Offset Method

Answer 11

plan formula is reduced by a fixed amount or a formula amount that is designed to represent the existence of Social Security benefits: no more than half of the benefit provided under the formula without the offset may be taken away by an offset

Question 12

Defined Benefits formula integration with Social security

Answer 12

-Excess method: provides a higher rate of benefits for compensation above the integration level/amount specified under plan by $ amount/formula
-benefit percentage cannot exceed the lesser of:
2 times the base percentage or,
the base percentage plus 5.7%.

Question 13

Maximum Integration Level Rules

Answer 13

As a general rule, a plan’s integration level cannot exceed an amount known as covered compensation. Qualified plans using permitted disparity generally use the Social Security wage base as the integration level.

Question 14

Defined Contribution Plans

Answer 14

the difference in the allocation percentages above and below the integration level can be no more than the lesser of:

The percentage contribution below the integration level, or
The greater of:
5.7%, or
The old-age portion of the Social Security tax rate. The IRS will publish the percentage rate of the portion attributable to old-age insurance when it exceeds 5.7%.

Question 15

Employer Contributions Vested under defined contribution plans

Answer 15

-3 year cliff vesting: 100% after 3 yrs
-2-6 year graded vesting: 2yrs->20% => 6+/100%

Question 16

Employer Contributions Vested under defined benefit plans

Answer 16

• 5 year cliff vesting
  -3-7 yr graded vesting

Question 17

Employer Matching Contributions vesting schedule

Answer 17

• 3 year cliff vesting
  -2-6 yr graded vesting

Question 18

Qualified plan funding requirements

Answer 18

Employer and employee contributions must be deposited into an irrevocable trust fund or insurance contract that is for the exclusive benefit of plan participants and their beneficiaries

Question 19

Pension Plans funding requirements

Answer 19

funding requirements that will compel the employer to provide either a contribution or the accrual of a benefit each year

Question 20

Profit Sharing plans

Answer 20

less restrictive “substantial and recurring” benchmark

Question 21

Defined Benefit Plan Funding Requirements

Answer 21

actuarial cost method determines the employer’s annual cost for a defined benefit plan

Question 22

Pension Protection Act of 2006

Answer 22

Plans must establish funding target = 100% PV of accrued benefits and factor in “Target Normal Cost”, benefits accrued during the plan year by participants. Plan assets must equal the accrued benefits that the plan must pay, any shortfalls to be amortized over 7 years

Question 23

Actuarial Assumptions

Answer 23

-Investment return on the plan fund
-Salary scale
-Mortality
-Annuity purchase rate
-Assumptions about future investment return and postretirement mortality
-Turnover

Question 24

Deduction limits

Answer 24

Greater of:
-Employer can contribute and deduct up to 25% of aggregate covered comp to a defined contribution plan
- Min standard for defined-benefit plan

Question 25

Timing of contributions

Answer 25

• defined benefit plan contributions must be paid within 8.5 months after end of plan year
  -defined contribution pension plan contributions must be paid within 2.5 months after end of plan year, subject to 6month extension

Question 26

Plan trustee fiduciary rules

Answer 26

can be a corporation or an individual, even a company president or shareholder, but are subject to stringent federal fiduciary rules

Question 27

Defined Benefit Limits

Answer 27

highest annual benefit payable under the plan must not exceed the lesser of:

100% of the participant’s compensation averaged over the three highest consecutive years of highest compensation, or
$265,000 (2023) (adjusted in $5k increments for COL indexing and retirement ages <>65

Question 28

Defined Contribution Limits

Answer 28

The annual additions (employer contributions, employee elective deferrals, forfeitures reallocated from other participants’ accounts) limit cannot exceed the lesser of:

100% of the participant’s annual compensation, or
$66,000(2023).

Question 29

Compensation limit

Answer 29

Only the first $330,000 (2023) of each employee’s annual compensation can be taken into account in the plan’s benefit or contribution formula (covered compensation)

Question 30

Top Heavy Requirements (provides more than 60% of its aggregate accrued benefits or account balances to key employees)

Answer 30

-100% vesting after three years of service or 6-year graded vesting and must provide minimum benefits or contributions for non-key employees.
-For defined benefit plans the benefit for each non-key employee during a top-heavy year must be at least 2% compensation x years of service up to 20%, ave compensation based on highest 5 years, must use accelerated vesting schedule
-For a defined contribution plan, employer contributions during a top-heavy year must be at least 3% of compensation

Question 31

Difference between HCE and key employee

Answer 31

-Highly Compensated: More than a 5% owner or received compensation in excess of $150,000 (2023) (indexed). ADP, ATP, 401k and coverage, Safe Harbor, Average Benefits
-Key Employee: Greater than a 5% owner or an officer of the employer having annual compensation greater than $215,000 or a greater than 1% owner whose salary exceeds $150,000. Top heavy, qualified plan, group life ins

Question 32

Loans

Answer 32

-Any type of qualified plan or Section 403(b) tax deferred annuity plan may permit loans, most common in defined contribution plans (profit sharing). More administrative difficulties for loans from defined benefits plans due to actuarial approach (loan not permitted from IRAs and SEPs).
-Permitted to encourage non-highly compensated employees to participate.

Question 33

Loan requirements

Answer 33

-available to all participants and beneficiaries on a reasonably equivalent basis
- not made available to highly compensated employees in an amount greater than the amounts made available to other employees
- in accordance with specific provisions regarding such loans set forth in the -plan
- bear reasonable rates of interest, and are adequately secured

Question 34

For eligibility purposes, a year of service is defined as

Answer 34

a 12-month period during which the employee has at least 1,000 hours of service

Question 35

Money Purchase Pension Plan

Answer 35

qualified employer retirement plan whereby:
-Each employee has an individual account, employer makes annual contributions of a specified %age up to 25%
-Benefits=accumulated amount of employer contributions, interest or other investment return
-may provide that the employee’s account balance is payable in one or more forms of annuities equivalent in value to the account balance.

USED when:
-employer wants simple to administer
-employees are young
- employees are willing to accept a degree of investment risk in their plan accounts, in return for the potential benefits
- some degree of retirement income security in the plan is desired
-employer seeks to reward long-term employee relationships

PROS:
-Simple, inexpensive and guarantees employees receive annual contribution
- Individual participant accounts allow participants to choose the investment allocation in their account from the choices offered in the plan
- Used when the employees are unionized and subject to collective bargaining, and preferred over Profit Sharing plan as subject to the Minimum Funding Standard and therefore, must be funded by the employer each year.

CONS:
-May be inadequate for older, HCE and general investment risks, does not allow for in-service distributions, unless rolled over to profit sharing plan (if spun-off to a profit-sharing plan, the accounts in the new plan must retain the money purchase restrictions on in-service distributions).

Question 36

Design Features of Money Purchase Pension Plans

Answer 36

-benefit formula requiring an employer contribution that is a flat percentage of each employee’s compensation, up to 25% on first $330,000, may also use a factor related to employee’s service, benefitting owners/key employees which may result in prohibited discrimination in small closely-held businesses.
-benefit formula can be integrated with Social Security, referred to as permitted disparity
-of employee leaves before fully vested, unvested/forfeiture can reduce future employer contributions or added to remaining participants’ account balances

Question 37

Tax Implications of Money Purchase Plans

Answer 37

-Employer contributions to the plan are deductible
-Employee contributions are tax deferred

Question 38

Alternatives to Money Purchase Pension Plans

Answer 38

-Target benefit pension plans
-Profit-sharing plans
-Defined benefit pension plans
-Nonqualified deferred compensation plans
-Individual retirement saving

Question 39

Profit Sharing Plan

Answer 39

• The employer’s contribution to the plan each year is discretionary
  -Each participant has an individual account in the plan
  -Plan benefits consist of Employer contributions, Forfeitures from other employees’ accounts, and interest, capital gains and other investment return realized over the years on plan assets.
  -distributes the employee’s account balance in a lump sum at termination

USED when:
-employer’s profits or financial ability to contribute to the plan varies
-employer wants to adopt a qualified plan with an incentive feature
-employees are relatively young and have substantial time to accumulate retirement savings.
-Employees are willing to accept a degree of investment risk in their accounts in return for the potential benefits of good investment results.
-When the employer wants to supplement an existing defined benefit plan

PROS:
-inexpensive and simple to design and implement
-provides maximum contribution flexibility from the employer’s viewpoint
-among the most portable as they can be rolled to other plans and IRAs

CONS:
-retirement benefits may be inadequate for employees who enter the plan at older ages
-Employees bear investment risk under the plan and there is no predictable level of employer funding

Question 40

Employer contributions to profit sharing plan

Answer 40

• discretionary
  -formula

Question 41

Allocation to Participant Accounts

Answer 41

must not discriminate in favor of highly compensated employees.

Question 42

Withdrawals/ in-service distributions

Answer 42

only in the event of hardship as specified in the plan, eg medical emergencies, home repair or educational expenses and cannot exceed the participant’s vested account balance

Question 43

Tax Implications of Profit-Sharing Plans

Answer 43

-Employer contributions to the plan are deductible, cannot exceed 25% of the payroll of all employees covered under the plan. Any excess over these limits is subject to a 10% penalty.
-taxation of the employee is deferred

Question 44

Savings Plan

Answer 44

-qualified defined contribution plan that is similar to a profit sharing plan, with features that provide for and encourage after-tax employee contributions to the plan. It is also called a thrift plan.
-After-tax employee contributions with matching employer contributions

USED:
- As an add-on feature to a Section 401(k) plan it allows employees to increase contributions beyond the annual limit on salary reductions under Section 401(k) plans
-When the employee group: relatively young/willing to accept risk/there is wide variation among employees
-When the employer wants to supplement the company’s defined benefit pension plan with a plan that features individual participant accounts and the opportunity for participants to save on a tax-deferred basis.

PROS:
-allows employees to control the amount of their savings
-Lump-sum distributions from the plan may be eligible for a special 10-year averaging tax computation available to certain employees born before 1936.

CONS:
-The plan cannot be counted on by employees to provide an adequate benefit
-Employees bear investment risk under the plan.
-As employee accounts and matching amounts must be individually accounted for in the plan, the administrative costs for a savings plan are greater than those for a money purchase or a profit-sharing plan without employee contributions.
-Employee contributions to a Savings or Thrift plan are counted towards the annual limit on annual additions and may limit the relative tax advantage available to highly compensated employees under a savings plan or any other defined contribution plan.

Question 45

Design Features of Savings Plans

Answer 45

-Employer (matching half up to 6%) and employee (1-60%) contributions towards the plan, matching contributions are subject to a faster vesting schedule
-Participant investment direction or earmarking (allowing employees a choice among several specified pooled investment funds such as mutual funds/life insurance), and
-Its use as an add-on to the Section 401(k) plan.

Question 46

Tax implications of Savings Plans

Answer 46

-Employer contributions to the plan are deductible
-Employee contributions are not tax deductible, employer contributions and investment earnings on both employer and employee contributions are tsx deferred
-Must meet actual contribution percentage (ACP) test
-Certain employers adopting a plan may be eligible for a business tax credit of up to $500 for qualified startup costs.
-A plan may permit employees to make voluntary contributions to a deemed IRA
-Certain employees born before 1936 may be eligible for a 10-year averaging tax calculation on lump-sum distributions.

Question 47

Actual Deferral Percentages (ADP)

Answer 47

prevent the plan from discriminating in favor of highly compensated employees. This test is applied to employee contributions in a 401(k) plan

Question 48

Actual Contribution Percentage (ACP) test

Answer 48

The ACP test is satisfied for a plan year if the average ratio of employee contributions plus employer matching contributions to compensation for the plan year does not exceed the greater of:
-125% contribution percentage/ratio for all other eligible employees for preceding plan year or
-Lesser of: 200% of contribution percentage for all other eligible employees or such percentage plus 2 percentage points for preceding plan year

Question 49

Section 401(k) plan

Answer 49

-qualified profit-sharing or stock bonus plan under which plan participants have the option to put money in the plan or receive the same amount as taxable cash compensation: cash or deferred arrangement (CODA)

• up to $22,500 annually, plus catch-up contributions

USED:
-When an employer wants to provide a qualified retirement plan for employees
-When an employer is willing to meet a minimal funding requirement for NHC employees and wants to maximize the contributions available to HC employees without annual ADP testing
-When an employer wants an attractive, savings-type supplement to its existing qualified retirement plan

PROS:
-degree of choice in the amount they wish to save under the plan
-employer may contribute and deduct up to 25% in addition to elective deferrals
-Traditional Section 401(k) plans can be funded entirely through salary reductions by employees
-Plan lump-sum distributions may be eligible for special tax treatment.
-In-service withdrawals by employees for certain hardships are permitted. These are not typically available in qualified pension plans, however, a pension plan may offer in-service distributions for participants having attained age 62.

CONS:
-annual employee salary reduction under the plan is limited to $22,500 (though catch up contributions of $7,500 allowed if 50+)
- can be relatively costly and complex to administer due to ADO test

Question 50

Roth 401(k) distributions

Answer 50

Withdrawals of less than the full amount of the account are made pro-rata with a portion of each withdrawal being taxable and tax-free., which is markedly different than the more favorable Roth-IRA distribution FIFO rules.
-if a distribution (rather than a direct transfer) of Roth 401(k) money is taken, only the un-taxed gains can then be rolled over to another Roth 401(k) plan within sixty days
-If loans from a Roth 401(k) should default, the outstanding balance will be treated as a non-qualified distribution and any earnings distributed are fully taxable and subject to a 10% excise tax.

Can avoid this by starting a Roth IRA 5 years prior to rolling over Roth 401k before 73

Question 51

Automatic Enrollment

Answer 51

Part of Pension Protection Act of 2006, also known as negative election whereby employee needs to take action to adjust/opt out of contributions. Combined with employer matching arrangement, that matches 100% of the first 1% contributed by the employee and 50% of other contributions up to 6% of pay will allow the plan to satisfy the ADP and ACP test as well as the Top Heavy Test.

Question 52

Simple 401(k) limit

Answer 52

lower annual elective deferral limit but must be coordinated with the other elective deferrals described previously. The limit for 2023 is $15,500, 50+ catch-up allowance is $3,500 (2023).

Question 53

Employer Contributions for 401(k)

Answer 53

-Formula matching contributions
-Discretionary matching contributions
-Pure discretionary nonelective contribution or profit sharing contributions
-Formula contributions

Employer matching contributions are subject to the same vesting requirements as are applied to top-heavy plans: 100% cliff vesting after 3 years or 2-6 graded vesting

Question 54

Nonelective Employer Contributions

Answer 54

help plan satisfy the ADP test, or may be selected under one of the permissible arrangements for a safe harbor or SIMPLE 401(k) plan

-QNEC: qualified Nonelective employer contributions can be used to help meet the ADP test only if they are immediately 100% vested and are subject to the same withdrawal restrictions applicable to elective deferrals

-If nonelective employer contributions that are not counted in the ADP test, then the employer contributions don’t need to be 100% vested. Graded vesting reduces employer costs for the plan as employees who leave employment before they are fully vested forfeit the nonvested part of their account balances. These forfeitures can then be used to reduce future employer contributions or, more commonly, can be redistributed to remaining participants’ accounts in the plan.

Question 55

401(k) Distributions

Answer 55

elective deferrals cannot be distributed prior to occurrence of one of the following:
-Retirement,
-Death,
-Disability,
-Severance from employment with the employer,
-Attainment of age 59 1/2 by the participant,
-Plan termination if the employer has no other defined contribution plan other than an ESOP, or
-Hardship.

Many 401(k) plans have provisions for plan loans to participants to allow them access to their plan funds without the hardship restriction or the 10% penalty tax.

Question 56

Tax Implications of 401(k) Plans

Answer 56

-Employee elective deferrals, that is, salary reductions up to the annual limit, are not subject to income tax to the employee in the year of deferral. The limit is $22,500 (2023) plus any permitted catch-up contributions. However, elective deferrals are subject to Social Security tax for the employee
-Employer matching and nonelective contributions to a traditional or safe harbor 401(k) plan are deductible by the employer for federal income tax purposes up to a limit of 25% of the total payroll
-Elective deferrals are subject to the Social Security Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA) payroll taxes.

Question 57

ADP Test

Answer 57

test for nondiscrimination in traditional 401k must satisfy one of following:
-ADP for eligible highly compensated employees for the plan year is not more than the ADP of all other eligible employees for the preceding plan year multiplied by 1.25.
-ADP for eligible highly compensated employees for the plan year does not exceed the ADP for other eligible employees for the preceding plan year by more than 2% and the ADP for eligible highly compensated employees for the plan year is not more than the ADP of all other eligible employees for the preceding plan year multiplied by two.

Question 58

Safe Harbor 401(k) Plans

Answer 58

Safe Harbor provisions to a 401(k) plan will eliminate the need for the ADP/ACP test thus allowing highly compensated employees to contribute the maximum elective deferral amount: The employer must provide one of these options plus immediate vesting under Safe Harbor 401(k) provisions:
-Matching Contributions must equal 100% of the first 3% of employee contributions and 50% of the next 2% of employee contributions, or
-Non-Elective Contributions for all eligible employees equal to 3% of their compensation.

Question 59

Target/Age Weighted Plan

Answer 59

formula for annual employer contributions or allocations to participant accounts is based not only on the participant’s compensation but also on the participant’s age on entering the plan, which allows higher contribution levels, as a percentage of compensation, for older plan entrants:
- target plan is an age-weighted money purchase pension plan
- age-weighted profit sharing plan is a profit sharing plan with an age-weighted factor
-cross-tested plan represents an attempt to push age-weighting to its maximum limit under the cross-testing provisions of the proposed nondiscrimination regulations under Code Section 401(a)(4).

USED:
-When the features of a regular defined contribution plan would be attractive to the employer, except that there are older employees whose retirement benefits would be inadequate because of the relatively few years remaining for participation in the plan. The age-weighted formula allows proportionately greater employer contributions for these older employees, that is, greater percentages of their compensation.
-When the employer is looking for an alternative to a defined benefit plan that provides adequate retirement benefits to older employees but has the lower cost and simplicity of a defined contribution plan.
-When an employer wants to terminate an existing defined benefit plan in order to avoid the increasing cost and regulatory burdens associated with these plans. If an age-weighted plan is substituted for the defined benefit plan, in many cases the new plan will provide approximately the same benefits to most employees, and it will be relatively easy to obtain IRS approval for the defined benefit plan termination.
-When a closely held business or professional corporation has key employees who are approximately age 50 or older and who generally want to contribute less than the annual additions dollar limit of $66,000 (2023). The age-weighted plan is generally the ideal qualified plan to adopt in this situation. Given the $66,000 (2023) annual limit, its benefit level is just as high as would be available in a defined benefit plan but is much simpler and less expensive to install and administer.

PROS:
-more of the total employer contributions in the age-weighted plan will likely be allocated to owners and key employees
-An age-weighted plan is especially simple compared to a defined benefit plan because actuarial valuations and an enrolled actuary’s certification are not required. Yet the plan’s benefits can be much the same as those from a defined benefit plan. In contrast, a target benefit plan or a cross-tested plan does require actuarial services.

CONS:
-Employees bear investment risk
-A target pension plan is subject to the Code’s minimum funding requirements
-In the case of a target pension plan or a cross-tested plan, actuarial services are needed on an annual basis.

Question 60

Target Benefit Plan

Answer 60

The annual contribution is a percentage of each employee’s annual compensation, with the percentage varying according to the age of the employee when that employee first entered the plan:
-The employer chooses a target level of retirement benefits as a percentage of annual compensation
-The plan designer chooses actuarial assumptions to determine how much must be contributed for each participant in order to provide the targeted level of benefit.

The percentage for each employee is determined when the employee enters the plan and remains the same thereafter. Unlike a defined benefit plan, there are no periodic actuarial valuations

Question 61

Limits on Actuarial Assumptions for target benefit table

Answer 61

The investment return assumption must not be 7.5-8.5%

Question 62

Section 415

Answer 62

Annual addition limits of lesser:
-100% of compensation, or
-$66,000 (2023).

Question 63

Age-Weighted Profit Sharing Plans

Answer 63

relates allocation percentages to age, thus resulting in a higher allocation for a participant who enters the plan at a later age.

Question 64

Tax implications of Target/Age Weighted Plans

Answer 64

-A target pension plan, but not an age-weighted profit-sharing plan, is subject to the minimum funding rules of Section 412 of the Code. This requires minimum annual contributions. For a target benefit plan, the minimum funding requirement is generally the amount required under the plan’s contribution formula. The minimum funding requirement, therefore, will be satisfied so long as the employer contributes to each participant’s account the percentage of compensation required by the plan.
-certain employers may be eligible for a business tax credit to offset qualified plan startup costs.

Question 65

Alternatives to Target/Age weighted plans

Answer 65

• Defined benefit plans provide more benefit security
  -Money purchase plans offer an alternative similar to target plans, but without the age-related contribution feature.
  -Nonqualified deferred compensation plans can be provided exclusively for selected executives
  -Individual retirement savings is available as an alternative or supplement to an employer plan, but the amounts may be subject to deduction and deferral limits.

Question 66

Matilda Sinclair is an employee of Maxwell Inc. Her earnings for this year are $48,000 and she participates in a money purchase plan that is integrated with Social Security. The plan provides for employer contributions of 15% of compensation above an integration level of $22,000 and 11% below the level. What is the total employer contribution to Matilda’s account this year?

Answer 66

A plan benefit formula that is integrated with Social Security avoids duplicating Social Security benefits already provided to the employee and reduces employer costs for the plan. An integrated formula defines a level of compensation known as the integration level. Employer contributions for compensation above the integration level are of a higher rate than the rate for compensation below the level. Maxwell Inc.’s contribution to Matilda’s account would be computed as follows: 11% of the first $22,000 of total compensation: $2,420 15% of $26,000 ($48,000 compensation - $22,000 integration level): $3,900 The employer contribution to Matilda’s account this year: $6,320.

Question 67

Lou has taken advantage of his employer’s Roth 401(k) plan. He will contribute $11,000 per year. If, in ten years at age 62, his account balance is $165,000 and Lou decides to withdraw his entire account balance, what will be the taxable portion of that withdrawal?

Answer 67

Since Lou satisfied the five year and is withdrawing his gains following age 59 ½, all gains are tax-free. Contributions are always tax free since they were made with after tax dollars.

Question 68

Defined Benefit Pension Plan

Answer 68

quarterly required contributions of Section 412(m) apply only to certain underfunded defined benefit pension plans, where

• objective to provide adequate retirement income to employees regardless of age at entry
  -allocate plan costs to max extent to older employees (often key/controlling employees in closely held business)
  -older controlling employee in a small business, for instance a doctor or dentist in a professional corporation, wants to maximize tax-deferred retirement savings, especially for self benefit.

PROS:
allows employers to contribute more than other retirement plans, with substantial, predictable retirement benefits
-benefit levels are guaranteed both by the employer and by the Pension Benefit Guaranty Corporation (PBGC)
-For an older highly compensated employee, a defined benefit plan generally will allow the maximum amount of tax-deferred retirement saving.

CONS:
complex in design and therefore entails additional administrative expenses for the employer
-Actuarial and PBGC aspects of defined benefit plans result in higher installation and administration costs
-Employees who leave before retirement may receive relatively little benefit from the plan. The plan generally lacks portability
-he employer assumes the risk of bad investment results in the plan fund.

Question 69

Formulas for Defined Benefit Plans

Answer 69

-The flat amount, appropriate only when there is relatively little difference in compensation among the group of employees covered under the plan
-The flat percentage, percentage of the employee’s average earnings
-The unit credit types, based on the employee’s service with the employer, using The career average, and
The final average methods. (a maximum of $330,000)

Question 70

Defined Benefit Funding

Answer 70

Employers must fund defined benefit plans with periodic deposits determined actuarially to insure that the plan fund will be sufficient to pay the promised benefit as each participant retires.

Question 71

412(i) Plans

Answer 71

defined benefit plan that is funded with a combination of life insurance and annuity contracts, with guaranteed rates of return as well as guaranteed annuity payouts over life, so no need to use actuary

Question 72

Tax Implications of Defined Benefit Pension Plans

Answer 72

-Under Code Section 415, there is a maximum limit on the projected annual benefit that the plan can provide. For a benefit beginning at age 65, the maximum life annuity or joint and survivor benefit is the lesser of:
$265,000 in 2023
100% of the participant’s compensation averaged over his three highest-earning consecutive years.
- subject to the minimum funding rules of Code Section 412
-Certain employers may be eligible for a business tax credit to offset qualified plan startup costs.

Question 73

Alternatives to Defined Benefit Pension Plans

Answer 73

-Money purchase pension plans provide retirement benefits, but without employer guarantees of benefit levels, and with adequate benefits only for younger plan entrants.
-Target benefit pension plans may provide adequate benefits to older entrants, but without an employer guarantee of the benefit level.
-Cash balance pension plans provide an employer guarantee of principal and investment earnings on the plan fund, but provide adequate benefits only to younger plan entrants.
-Profit sharing plans, SEPs, stock bonus plans and ESOPs provide a qualified, tax-deferred retirement savings medium, but the benefit adequacy is tied closely to the financial success of the employer and thus whether or not the employer makes consistent contributions.
-Section 401(k) plans, savings plans and SIMPLE IRAs provide a qualified, tax-deferred savings medium in which the amount saved is subject to some control by employees themselves.
-Private retirement saving outside a qualified plan does not provide the same tax benefits as saving within a qualified plan, except in the case of certain IRAs, but is limited to the amount that can be put away annually.

Question 74

Cash Balance Pension Plan

Answer 74

provides for annual employer contributions at a specified rate to hypothetical individual accounts that are set up for each plan participant

USED:
company with a large, young, middle-income work force that desires a secure retirement income will find the cash balance pension plan appropriate
-When the employer is able to spread administrative costs over a relatively large group of plan participants.
-When the employer has an existing defined benefit plan and wishes to convert to a plan that provides a more attractive benefit for younger employees and lower costs for older employees.

PROS:
-Lump-sum distributions from a cash balance plan may be eligible for special tax treatment.
-The employer guarantee removes investment risk from the employee.
-Plan benefits are guaranteed by the federal PBGC.
-The benefits of the plan are easily communicated to and appreciated by employees.

CONS:
-may be inadequate for older plan entrants.
- more complex administratively than qualified defined contribution plans due to need for actuarial services and min funding requirements and PBGC guarantee.
The shift of investment risk to the employer increases employer costs.

Question 75

Design Features of Cash Balance Plans

Answer 75

Hypothetical individual accounts are credited by the employer at least once a year with two types of credit:

-The pay credit (formula based on compensation), may be integrated with social security, and
The interest credit (each employee’s account to be credited annually with a rate of earnings defined as the lesser of:
-The increase in the Consumer Price Index over the preceding year, or
-The one-year rate for U.S. Treasury securities.) OR with actual plan earnings if higher

-Not allowed earmarking/investment discretion since not individual account plan under ERISA

-Loans from the plan can be made available, but most employers will not want a loan provision because of the administrative problems resulting from the plan’s status as a defined benefit plan without separate participant accounts. Life insurance can be purchased by the plan as an incidental benefit to participants or as a plan investment.

Question 76

Modification of Formula

Answer 76

If employer would like to change the plan because not attractive enough benefits for younger employees and too costly for older employees, then existing plan formula may be revised into a cash balance and covered employees would receive the greater of amount provided under new cash balance formula or amount of benefit accrued under old benefit formula up to date of adoption of new formulate (frozen benefit)

-If the employer amends a defined benefit plan to adopt a cash balance formula, the plan administrator must provide a prescribed written notice to affected plan participants and beneficiaries, otherwise subject to penalty per EGTRRA 2001

Question 77

Tax Implications of Cash Balance Pension Plans

Answer 77

-The plan is subject to the minimum funding rules of Section 412 of the IRC
-A cash balance plan is considered a defined benefit plan and is subject to mandatory insurance coverage by the PBGC.
-A plan may permit employees to make voluntary contributions to a deemed IRA established under the plan.

Question 78

The maximum annual deductible employer contribution to a profit-sharing plan is

Answer 78

25% of aggregate covered compensation.

Question 79

Which of the following is NOT a component in applying the annual additions limit?

Answer 79

Participant account earnings attributed to employer contributions

Question 80

Which plan must pass the 50/40 test?

Answer 80

all defined benefit plans are required to cover the lesser of

50 employees or
40% or more of all eligible employees.

Question 81

Under the excess method for integration with Social Security, what is the maximum excess contribution rate to the plan if the base contribution percentage is 5%

Answer 81

Under the excess method, the maximum excess contribution rate for compensation above the compensation threshold is the lesser of:

2x the base contribution rate or
the base contribution rate plus 5.7%.
In this example, the lesser of 2x the base contribution rate (2 x 5% = 10%) is the maximum excess contribution.

Question 82

The maximum annual deductible employer contribution to a defined benefit plan is

Answer 82

the necessary contribution to assure the plan assets equal the accrued benefits the plan must pay

Question 83

What correctly describes a qualified plan that would be deemed top-heavy?

Answer 83

A plan in which more than 60% of the plan benefits or contributions are for KEY EMPLOYEES is deemed top-heavy.

Question 84

Lucia is self-employed with net earnings from self-employment of $120,000. She has two full-time employees who each earn $40,000 per year. Lucia maintains a profit-sharing plan for herself and her employees. Her SE tax is $16,955 and her FICA taxes for her employees are $6,120. What is the effective maximum deductible percentage of total covered compensation she can make to the profit-sharing plan this year?

Answer 84

The effective maximum deductible percentage of total covered compensation she can make to the profit-sharing plan this year is 21.15%. The maximum deductible plan contribution is 25%. Under the maximum contribution, Lucia can receive a contribution of $22,304 and her two employees can each receive $10,000.

The total is $42,304. $42,304 ÷ ($120,000 + $40,000 + $40,000) = .2115

Question 85

Svetlana, age 50, is a participant in her employer’s very generous cash balance plan. Her annual salary is $400,000. The cash balance plan is funded each year to provide the maximum benefit at the plan’s normal retirement age of 65. In 2023, what is the maximum compensation upon which Svetlana’s pension benefit may be funded?

Answer 85

In 2023, the maximum compensation upon which a defined benefit pension may be funded is $330,000.

Question 86

In 2023, what is the maximum annual pension that can be funded in a cash balance pension plan?

Answer 86

The maximum annual pension that can be funded in a cash balance pension plan in 2023 is $265,000.

Question 87

Joaquin, age 62, is an executive of JPCo, Inc., earning $400,000 per year. His company adopted a traditional defined benefit pension plan several years ago with a benefit formula of 2% of a participant’s final 3 years average compensation times the participant’s years of service, up to 35 years. Assuming Joaquin will have 20 years of service at retirement at age 65 and his compensation increases 10% annually the next 3 years, what is Joaquin’s currently projected annual pension?

Answer 87

With 20 years of service at retirement, Joaquin’s pension will be 40% (2% x 20 yrs) of his final 3 years average compensation. However, Joaquin’s compensation exceeds the maximum compensation threshold of $330,000 (2023), so his pension is currently projected to be 40% x $330,000 = $132,000.

Question 88

Which of the following statements correctly describes the circumstance under which an employee is considered an “active participant” in a traditional defined benefit pension plan for IRA contribution deduction purposes?

Answer 88

If an employee is eligible for participation in a traditional defined benefit pension plan, they are accruing a pension benefit. This accrual makes them an active participant in a qualified plan for IRA contribution deduction considerations.

Question 89

What is the annual maximum deductible employer contribution to a target benefit pension plan?

Answer 89

Combined contributions subject to annual additions limit of $66,000