Book 5 Page 1 - 53 Flashcards
the most common model used for retirement needs analysis
Pure Annuity Model
true or false?
the pure annuity model determines needs on a pre-tax basis
true
Margie, age 41, currently earns $80k. Her wage replacement ratio is determined to be 80%. She expects inflation to average 3% for her entire life expectancy. Margie expects to earn 10% on her investments and retire at age 62, living possibly until age 90. Her Social Security benefit statement indicates her social security retirement benefit in today’s dollars for early retirement is $12,000 per year. She will make retirement savings contributions at the end of each month.
How much will Margie need by age 62 and how much will she have to save per month from now until retirement (62)?
Step 1:
n = 62 - 41 = 21 I = 3% PV = (80k x 80% - 12k) = $52k PMT = 0 FV = $96,735.32 (first year income needed at retirement)
Step 2: Set to beginning mode n = 90 - 62 = 28 i = (1.1 / 1.03) - 1 x 100% = 6.7961 FV = 0 PMT = $96,735.32 PV = $1,278,954.46 (amount needed by age 62)
Step 3: set back to end mode FV = $1,278,954.46 n = 21 x 12 = 252 i = 10/12 = .833% PV = 0 PMT = $1,502.09 (monthly retirement savings from now until age 62)
maintains the original balance needed at retirement under the pure annuity model for the entire retirement life expectancy
Capital preservation model
maintains the purchasing power of the original pure annuity capital balance at retirement
purchasing power preservation model
what is the biggest difference between the capital preservation model and the purchasing power preservation model?
the purchasing power preservation model uses an inflation adjusted interest rate but the capital preservation model does not
true or false?
a contingent deferred sales charge is considered a commission
true
carries out the administrative duties of the qualified plan system and to lesser extent, the nonqualified plan system
Internal Revenue Service (IRS)
the federal legislation that governs the non tax aspects of retirement plans and other employee benefits
ERISA ( Employee Retirement Income Security Act)
____ is intended to protect retirement interests of plan participants
ERISA
___ established equitable standards and curtailed potential plan participants
ERISA
protects the employees’ right to collect benefits and imposes nondiscrimination and funding requirements
Title I of ERISA
establishes plan qualification requirements for special treatment under the internal revenue code
Title II of ERISA
creates the regulatory and administrative framework for ongoing ERISA implementation
Title III of ERISA
establishes the Pension Benefit Guaranty Corporation to insure defined benefit plan benefits
Title IV of ERISA
what entities does ERISA require reporting and disclosure of plan information be sent to?
- IRS
- DOL
- PBGC
- Plan Particpants
___ is involved in retirement plans through its Office of Pension and Welfare Benefit Plans
DOL
the ___ ensures compliance with the plan reporting and disclosure rules
DOL
true or false?
a summary plan descriptions is the most significant disclosure requirement under the DOL
true
what is the goal of prohibited transaction rules?
to keep the interest of the plan separate from the sponsoring entity
a federal corporation created by ERISA to insure plan participants against loss of benefit due to the termination of a pension plan
Pension Benefit Guaranty Corporation (PBGC)
true or false?
defined benefit and defined contribution plans are both insured by the PBGC
false, only defined benefit plans are insured
what is the maximum amount that PBGC will insure for 2017?
$64,428 (per year)
Professional service employers with ___ or fewer active participants are exempt from PBGC insurance requirements
25
for what reasons can the PBGC terminate a defined benefit plan?
- minimum funding standards are not met
- benefits cannot be paid when due
- the long run liability of the company to the PBGC is expected to increase unreasonably
transactions that are contrary to the interest of plan participants
prohibited transactions
give some examples of prohibited transactions
- sale/exchange/lease of property between the plan and a party in interest
- loan between the plan and any party in interest
- transfer of plan assets to or use of plan assets for the benefit of a party in interest
- acquisition of employer securities or real property in excess of legal limits
- self-dealing
qualified plans must satisfy reporting and disclosure requirements of ___
ERISA
an ERISA report that includes detailed financial information and actuarial information
form 5500
form 5500 is filed with ____
EBSA (employee benefits security administration)
similar to form 5500 but is used for plans that have fewer than 25 participants, are eligible for the small plan audit waiver, hold no employer securities, and have 100% of assets in investments that have a readily determinable FMV
form 5500 - SF
true of false?
form 5500 - EZ covers a business for which leased employees perform services
false
true of false?
form 5500 - EZ covers a business that is part of a controlled group
false
similar to form 5500 and 5500-SF but is used for plans that consist of an individual and their spouse or partners and their spouses
form 5500 - EZ
explains how the plan works, what benefits are available, and how to get the benefits
summary plan description
true or false?
a summary plan description must be provided to all plan participants
true
a new SPD must be issued at least every ___ years
10
a summary of the information on the annual report
summary annual report
true or false?
a summary annual report must be provided to plan participants each year
true
explains changes that occurred to the SPD within the last year
summary of material modification
true or false?
a summary of material modification must be provided to the plan participants each year
false, only as changes happen
defined contribution plans must provide benefit statements at least ____ to participants who direct their own investments and ____ to those who cannot
quarterly ; annually
true or false?
under a qualified plan the employer receives immediate deductibility of all contributions made to the plan
true
true or false?
nonqualified plans are subject to the same ERISA rules as qualified plans
false
true or false?
nonqualified plans are usually discriminatory in favor of highly compensated employees
true
benefits under a nonqualified plan are not taxable as long as there is a _____
substantial risk of forfeiture
true or false?
benefit payments are not deductible by the employer until they are paid
true
pension plans promise either a ____ or ____
benefit or contributions
true or false?
annual funding is not mandatory under a pension plan
false, it is mandatory
true or false?
profit sharing plans require annual funding
false, they do not
defined benefit plans and target benefit plans are tested for discrimination on the basis of ____ as opposed to ____
benefits ; contributions
provide salary continuation through excess benefits or contributions that exceed qualified plan annual addition limits
excess benefit plans
an accounting entry without actual stock ownership
phantom stock plans
gives the right to the monetary equivalent of the increase in the value of shares of stock over a specified period
stock appreciation rights
may be used to provide contributions and benefits in excess of IRC limits for key executives
SERP (supplemental executive retirement plan)
true or false?
employer contributions to qualified plans are subject to payroll taxes
false, they are not
true or false?
if loans are permitted under a qualified plan then the loan is considered a taxable distribution
false
qualified plans are protected from creditors by ____
ERISA
certain small employers are eligible for a tax credit of up to $___ in start-up costs or employee education expenses incurred in connection with the adoption of a qualified plan
$500
a favorable ruling requested from the IRS that the proposed qualified retirement plan provisions meet tax code requirements
Advance determination letter
what is the difference between a master plan and a prototype plan in regards to qualified plans?
a master plan uses only a single financial institution for funding where as a prototype plan usually allows for more funding possibilities
true or false?
a qualified plan is either a pension plan or profit sharing plan
true
true or false?
in service withdrawals from certain pension plans are permitted for employees age 62 or over
true
true or false?
a 401k plan is an example of a profit sharing plan
true
true or false?
an ESOP is an example of a profit sharing plan
true
true or false?
a stock bonus plan is an example of a profit sharing plan
true
pension plans may only hold ___% of the employer’s securities
10%
profit sharing plans may only hold ___% of the employer’s securities
100%
what is the deductible contribution limit for the employer for profit sharing plans?
25% of covered compensation
what is the deductible contribution limit for the employer for defined contribution plans?
25% of covered compensation
what is the deductible contribution limit for the employer for defined benefit plans?
the actual amount determined needed to fund the future promised benefit
under a defined contribution plan the investment risk shifts to the ____
employee
under a defined benefit plan the investment risk shifts to the ____
employer
pension plans that provide a specific benefit to the employee
defined benefit plans
true or false?
defined benefit plans may be costly to administer
true
true or false?
defined contribution plans use an individual account for each employee
true
true or false?
defined benefit plans use an individual account for each employee
false, the funds are commingled in a single account
what type of qualified plans meet the following objective:
to provide a savings medium that employees perceive as valuable
ESOP stock bonus plan profit sharing Thrift plan 401k SEP plan Target Benefit Pension Plan
what type of qualified plans meet the following objective:
to provide adequate replacement income for each employee’s retirement
defined benefit plan
reasons why:
it can provide a benefit based on final average compensation regardless of the employee’s years of service
no investment risk for employee
employer funding for benefit is mandatory
what type of qualified plans meet the following objective:
to weight the allocation of plan contributions to older employees
defined benefit plan
age based profit sharing plan
target benefit pension plans
what type of qualified plans meet the following objective:
to create an incentive for employees to maximize performance for the company
profit sharing plan
ESOP
stock bonus
what type of qualified plans meet the following objective:
to minimize turnover
defined benefit plans that use a graduated vesting schedule
what type of qualified plans meet the following objective:
to encourage early retirement
defined benefit plans
what type of qualified plans meet the following objective:
to provide the employer with maximum contribution flexibility
traditional profit sharing plans
SEP plans
true or false?
a qualified plan must be in writing
true
true or false?
the plan document provides the terms and benefit amounts provided by the plan
true
under qualified plans, a year of service means a 12 month period during which the employee has worked at least ____ hours
1,000
qualified plans cannot make an employee wait more than ____ months to enter the plan after meeting the eligibility requirements
6
under a qualified plan, the employer must cover at least ___% of all nonexcludable, nonhighly compensated employees
70%
know as safe harbor test
states that the plan must cover a percentage of nonhighly compensated employees that is at least 70% of the percentage of highly compensated employees covered
ratio test
how to calculate ratio test
% NHC covered / % HC covered
if greater than 70% then meets requirement
how to calculate the average benefits percentage test
average benefits % NHC / average benefits % HC
if greater than 70% then meets requirement
ABC employs 200 eligible employees of whom 10 are highly compensated. Nine of the 10 highly compensated and 120 of the 190 nonhighly compensated employees benefit from the plan. The average benefit for the HCE is 8% and 6% for NHCE
Does the plan meet the safe harbor test?
Does the plan meet the ratio percentage test?
Does the plan meet the average benefit percentage test?
safe harbor test is not met
120/190 = 63% (needs to be 70%)
ratio test is met
63%/90% = 70%
average benefit percentage test is met
6%/8% = 75%
a highly compensated employee is one who is either a ____% or more owner or had compensation of $_____ or more in the preceding year
5% ; $120k
all defined benefit plans must benefit no fewer than the lesser of ___ employees or ____% or more of all nonexcludable employees
50 ; 40%
true or false?
a defined benefit pension plan must meet the safe harbor test, ratio percentage test, or average benefit percentage test
true
what is a noncontributory plan?
plan where employer makes all of the contributions
give an example of a noncontributory plan
pension plans and some profit sharing plans
what is a contributory plan?
plan where employee makes some of the contributions
give an example of a contributory plan
401k and thrift plan
employer contributions deductibility under a qualified plan are limited to ___% of covered employee payorll
25%
a plan that provides more than 60% of its aggregate accrued benefits or account balances to key employees
top heavy plans
when is a defined benefit pension plan considered to be top heavy?
if the present value of accrued benefits for key employees is greater than 60% of the present value of accrued benefits for all employees
when is a defined contribution plan considered to be top heavy?
if the aggregate of account balances of key employees exceeds 60% of the aggregate account balances of all employees
true or false?
if a defined benefit pension plan is top heavy it must provide more rapid vesting than is generally required
true
if a defined benefit pension plan is top heavy, what are the minimum vesting requirements?
3 year cliff or 2-6 year graduated
true or false?
regardless if top heavy or not, a defined contribution plan must provide 3 year cliff vesting or 2-6 year graduated
true
a type heavy defined benefit pension plan must provide a minimum benefit accrual of ___% multiplied by the number of years of service up to ___%
2% ; 20%
true or false?
for employees who have already accrued a benefit of at least 20% under a defined benefit pension plan, the top heavy rules are irrelevant because they will receive their normal benefit
true
for a defined contribution plan that is top heavy, the minimum contribution is ___% of total covered compensation
3%
true or false?
if a defined contribution plan is top heavy and key employees receive a contribution less than the 3%, the contribution to non key employees still has to be 3%
false, it can be equal to the contribution for key employees
the number of officers who may be considered key employees is limited to the lesser of ___ and ___
50 employees ; greater of three employees or 10% of all employees
who is considered a key employee?
an officer who earns $175k or more
greater than 5% owner
greater than 1% owner with comp greater than $150k
true or false?
qualified plan benefit and contribution formulas can be integrated with SSI
true
employer and employee each contribute ___% of compensation to the OASDI
6.2%
what are the two methods that defined benefit pension plans can be integrated with SSI?
excess method
offset method
method where the plan defines a level of compensation, called the integration level, and then provides a higher rate of contribution and benefits for compensation above the integration level
excess method
method where a fixed amount or a formula amount that is designed to represent the existence of SSI benefits reduces the plan formula
offset method
the maximum difference between the benefit percentage below and above the covered compensation level is ___ of ___ multiplied by years of service up to __ years
3/4 ; 1 ; 35
what is the maximum increase in benefits for earnings above the covered compensation level?
3/4 * .01 * 35 = 26.25%
true or false?
defined contribution plans can be integrated with SSI using both the excess method and offset method
false, only excess method
the excess method provides higher contribution levels ____ the integration level than ___ the integration level
above ; below
the benefit level below the integration level is called the ___
base percentage
the benefit level above the integration level is called the ___
excess percentage
under a defined contribution plan, the excess percentage is limited to the lesser of of ___ or ___
two times the base percentage or the base percentage plus 5.7%
the difference between the base percentage and the excess percentage
maximum permitted disparity
Assume ABC company sponsors a money purchase pension plan, plan that provides a base contribution of 10% and an excess percentage of 15.7%. Assume the integration level and the social security wage base for this example equals $127,200. What will the contribution to the money purchase plan equal for employees 1, 2, and 3 if their compensations is $50k, $150k, and $280k respectively?
employee 1
total contribution = $5,000
calc as follows: $50k x base contribution % (10%)
employee 2
total contribution = $16,300
calc as follows: $127,200 x base contribution % (10%)
+ ($150k - $127,200) * 15.7%
employee 3
total contribution = $35,140
calc as follows: $127,200 x base contribution % (10%)
+ ($270k - $127,200) * 15.7%
$270k is used instead of $280k because $270 is the maximum covered compensation for 2017
true or false?
the integration level can exceed the social security taxable wage base
false
true or false?
ESOP’s can be integrated with Social Security
false
true or false?
SIMPLE’s cannot be integrated with Social Security
true
can a SARSEP be integrated with Social Security?
no
true or false?
employee elective deferrals to 401k plans cannot be integrated with social security
true
true or false?
employer matching contributions to 401k plan can be integrated with social security
false
can a profit sharing contribution by the employer to a 401k plan be integrated with Social Security?
yes
what are the vesting requirements for a non top heavy defined benefit pension plan?
5 year cliff
3-7 graduated
cash balance pension plans require a ___ year cliff schedule
3
true or false?
if a qualified plan consists of some employee contributions, the contribution amount and earnings based on those amounts are always 100% vested
true
true or false?
for vesting purposes in regards to qualified plans, an employee’s years of service typically begin on the hire date, not the date they become eligible for the plan
true
true or false?
all contributions to SEP plans are fully vested
true
true or false?
all contributions to SARSEP plans are fully vested
true
true or false?
all contributions to SIMPLE’s are fully vested
true
true or false?
safe harbor contributions to a safe harbor 401k are always 100% invested
true
annual additions to a defined contribution plan cannot exceed the lesser of ___% of the participant’s annual compensation or $____
100% ; $54,000
the benefit paid from a defined benefit plan at retirement cannot exceed the lesser of ____% of the participants covered compensation averaged over the ___ highest consecutive years or $_____
100% ; 3 ; $215,000
in 2017, only the first $____ of each employee’s compensation may be used to calculate contributions and benefits for any qualified plan
$270,000
employers that have a significant degree of common ownership
controlled groups
all loans under a qualified plan must be repaid within ___ years unless loans used to acquire____
5 ; principal residence
generally loans are limited to __% of the present value of the participant’s nonforfeitable accrued benefit or vested account balance
50%
generally loans from a qualified plan cannot exceed $___
$50k
when account balances are less than $20k, loans up to ____ are available
$10k
when account balances are less than $10k, loans up to ___ are available
the vested balance
loans from a qualified plan must have payments made at least ___
quarterly
when account balances are between $20k and $100k , loans up to ___ are availabe
50% of vested account balance
true or false?
upon termination of a qualified plan, all employees of the plan become fully vested in their benefits as of the date of termination
true
what is the objective of a defined benefit plan?
to provide a defined level of retirement income to each employee regardless of age at plan entry
true or false?
the employer must have stable cash flow to implement a defined benefit plan
true
when are employees taxed under a defined benefit plan?
when the benefit is received, usually in retirement
true or false?
benefit levels under a defined benefit plan are guaranteed
true
true or false?
one advantage of defined benefit plans is that it can encourage older employees to retire thus reducing the cost to the employer
true
true or false?
defined benefit plans are typically more costly than defined contribution plans
true
true or false?
defined benefit plans are not complex to design
false, they are complex
are employers subject to mandatory annual funding under a defined benefit plan?
yes
a ___ amount formula does not differentiate among employees with different compensations
flat
true or false?
a flat benefit formula does not use an accrued benefit actuarial cost method
true
give an example of a flat amount benefit under a defined benefit plan
$800 per month if you have 15 years of service. 3% reduction for every year below 15 years of service
provides a retirement benefit that is a percentage of the employee’s average earnings
flat percentage formula
what is the most common type of benefit calculation under a defined benefit plan?
unit benefit (credit) formula
give an example of a unit credit formula
1.5% of earnings for each year of service
true or false?
a unit benefit method must use an accrued benefit cost actuarial method
true
under a defined benefit plan, if investment returns increase for a given year then plan costs _____
decrease
under a defined benefit plan, if the life expectancy of a participant increases then plan costs ____
increase
under a defined benefit plan, if employee turnover increases then plan costs ____
decrease
under a defined benefit plan, if mortality decreases then plan costs ____
increase
under a defined benefit plan, if wages increase then plan costs ____
increase
employer contributions to a defined benefit plan are or are not tax deductible in the year they’re made?
they are tax deductible
a termination under a defined benefit plan that requires the plan to have sufficient funds to cover benefits accrued to the date of termination
standard termination
a termination under a defined benefit plan that requires the employer to be liquidated or that the termination be necessary for company’s survival
distress termination
PBGC insurance does not cover benefits added to a plan less than ____ years before a distress termination
5
a hybrid plan designed to address the shortfalls in 401k plans and a decline in the establishment of defined benefit plans
DB(k) plan
a sponsoring employer with no more than ___ employees may of the DB(k) plan
500
true or false? a DB(k) plan allows an employee to contribute to a defined benefit plan
true
true or false?
DB(k) plans are exempt from top heavy rules
true
true or false?
DB(k) plan costs are more predictable than regular defined benefit plans
true
a plan that provides for annual employer contributions at a specified rate to hypothetical individual accounts that are maintained on behalf of each plan participant
cash balance pension plan
a plan where the employer guarantees a contribution level and an interest rate credit to each participants’ account
cash balance pension plan
true or false?
a cash balance pension plan hypothetically allows an employer to contribute less to the plan than a money purchase pension plan would
true
which plan has broader investment risk, a money purchase pension plan or a cash balance pension plan?
cash balance pension plan
true or false?
cash balance pension plans must use a 3 year cliff vesting schedule
true
when is a cash balance pension plan appropriate to use?
when the employee group is relatively young
when employees are concerned with security of retirement income
when the work force is large and the employees are primarily middle income wage earners
when the employer is able to spread admin costs over a large group of plan participants
does the employee or employer hold the investment risk in a cash balance pension plan?
employer
are plan benefits under a cash balance pension plan guaranteed by the PBGC?
yes
true or false?
cash balance pension plans are less costly than defined benefit pension plans
true
true or false?
under a cash balance pension plan an employer must contribute a level amount to each employee
false, they don’t have to. They could can have higher contributions for employee’s with longer years of service
which type of plan is more favorable to older entrants, a defined benefit pension plan or a cash balance pension plan?
defined benefit pension plan
a type of traditional defined benefit pension plan funded exclusively by cash value life insurance or annuity contracts
fully insured defined benefit pension plan
who holds the investment risk in a fully insured defined benefit pension plan?
the insurance company (or other third party)
what type of business is the best prospect for using a fully insured defined benefit pension plan?
a stable business with cash flows that are not fluctuating
true or false?
defined contribution plans favor younger participants
true
admin costs under a defined contribution plan are ____ than for defined benefit pensions plans
lower
true or false?
employer costs under a defined contribution plan are easily determinable
true
true or false?
a money purchase pension plan is a type of a defined contribution plan
true
true or false?
contributions under a money purchase pension plan are mandatory
true
under a money purchase pension plan, employers can deduct contributions up to ___% of total covered compensation paid to the employees
25%
what plan is easier to administer, a money purchase pension plan or a defined benefit pension plan?
money purchase pension plan
true or false?
a money purchase pension plan requires the services of an actuary
false
does a money purchase pension plan require the employer to purchase plan benefit insurance from the PBGC?
no
true or false?
a money purchase pension plan is the least costly pension plan to administer
true
do money purchase pension plans favor younger or older employees?
younger
can after-tax contributions be made to a money purchase pension plan?
yes, if the plan document permits it
true or false?
in most cases, a profit sharing plan is a better choice than a money purchase pension plan because a profit sharing plan has greater flexibility
true
a money purchase pension plan cannot have more than ___% of plan assets in qualifying employer securities
10%
can money purchase pension plans be integrated with social security?
yes
true or false?
profit sharing plans have mandatory funding requirements
false
the legal promise of a profit sharing is to _____
defer taxes
how many investment choices does ERISA require a profit sharing plan to have?
3 at least
for a profit sharing plan to remain viable, contributions must be ____ and ____, which means a contribution must be made in ___ out of every ___ years
substantial and recurring
3 ; 5
when should a profit sharing plan be used?
when an employer’s profits or financial ability to contribute to the plan vary from year to year
when employees are relatively young
when employees are willing to accept a degree of investment risk
when the employer wants to adopt a qualified plan with an incentive feature by which employer contributions increase with the employer’s profits
