Chapter 16 Part 2

Question 1

generally are not subject to the guidelines set by ERISA

Answer 1

Governmental and church retirement plans

Question 2

parties in interest

Answer 2

Individuals who provide services to the plan, such as attorneys, accountants, and actuaries, are considered parties in lnterest as long as they are acting solely in their professional capacities. ErISA prohibits the following transactions between a plan and parties in interest” Selling, exchanging, or leasing property to the plan; Lending money or extending credit to the plan; Furnishing goods, services, or facilities to the plan; Transferring or using plan assets for their own benefit

Question 3

Fiduciary

Answer 3

anyone exercising discretionary authority or responsibility for the administration of the plan, exercising discretionary authority or control involving the management or disposition of plan assets, or providing investment advice for compensation. Investment advisers have a fiduciary duty to their clients. This duty is even greater when the client is a qualified pension plan subject to ERISA guidelines. Based on the increased responsibility given to fiduciaries, ERISA established additional rules, that expanded on protecting the interests of retirement plan asset holders. Two of these rules arc 404(b) and 404(c).

Question 4

eRISA Rule 401(b) states that “ … except as authorized by the Secretary of Labor by regulation, no fiduciary may maintain the

Answer 4

indicia (record) of ownership of any assets of a plan outside the jurisdiction of the district courts of the United States.” In common English, this rule requires that retirement plan assets be held in a location that is subject to U.S. federal court jurisdiction. This requirement prevents fiduciaries from acting outside of the U.S. regulator’s jurisdiction. As an additional safeguard, retircrnent plans that arc subject to ErISA are also required to n1aintain a fidelity bond. The purpose of the bond is to ensure that the plan participants are protected against
theft or embezzlement by employees of the trustee and/or custodian.

Question 5

A fiduciary must also follow the ERISa 404(c) rules governing fiduciary conduct that include:

Answer 5

Acting solely in the interest of plan participants and their beneficiaries; Discharging their duties for the exclusive purpose of providing benefits and defraying reasonable expenses of plan administration; Acting with the same care, skill, prudence, and diligence that a prudent person familiar with such matters would use (prudent person standard); Giving appropriate consideration to all relevant facts and circumstances; Diversifying plan investments in order to protect against the risk of large losses. ERISA does not specifically forbid particular investments. The following factors should be taken into consideration in determining whether the plan is diversified properly: The purpose of the plan; Geographical diversification; The amount of plan assets; Industry diversification; Financial and industrial conditions; Dates of maturity (if applicable); The type of investment

Question 6

Fiduciaries may not deal with plan assets in their own

Answer 6

interest or for their own account (e.g., recommending the purchase of a security in order to maintain its price for the benefit of an affiliated broker-dealer).

Question 7

Fiduciaries may not receive personal consideration from

Answer 7

any person dealing with the plan in a transaction involving plan assets (e.g., receiving a fee from an unaffiliated broker-dealer in return for using that broker-dealer to execute trades for the plan).

Question 8

Fiduciaries may not act on behalf of any person whose interests are

Answer 8

opposed to the plan in a transaction involving the plan (e.g., having the plan purchase a limited partnership from the account of another client of the adviser).

Question 9

An Investment Policy Statement is a document that describes

Answer 9

a plan’s investment strategy as well as the specific needs of the plan. A properly drafted IPS should outline the prudence and diversification standards that plan fiduciaries must follow, and should include such elements as investment philosophy, risk tolerance, time horizons, preferred asset classes, rate of return expectations, and long-term goals for the plan. In other words, the statement serves as a blueprint that is used to determine how investment decisions are made. The plan participants and/or the plan trustees may sue an investment adviser that does not follow the terms of the IPS. Even if the plan’s assets have increased under its management, an investment adviser that ignores the IPS may be held liable for breach of fiduciary duty.

Question 10

qualified plans receive

Answer 10

favorable tax treatment and the following ERISA standards apply.

Question 11

Qualified Plans Eligibility Requirements

Answer 11

The plan must cover all full-time employees who are 21 years of age or older and have worked for the employer generally for one year or more. If more than one year of service is required, then employees who participate in the plan must be 100% vested immediately.

Question 12

Qualified Plans Vesting

Answer 12

This is the schedule under which an employee gradually acquires the right, by length of service, to receive employer-contributed benefits. Note that employees are always 100% vested in their own contributions to a plan.

Question 13

Qualified Plans Funding

Answer 13

The investment of plan assets, together with other plan activities, is governed by strict fiduciary guidelines.

Question 14

Qualified Plans Plan Participants

Answer 14

Under Section 404(c) of ERISA, a separate account must be maintained for each participant. There must be al least three core investment alternatives to choose from various risk levels, and participants have the right to give instructions to the plan fiduciaries. Employers interested in establishing a qualified retirement plan may seek advance determinations from the IRS that the plan meets the required standards. Also, employers may adopt an existing IRS approved master or prototype plan provided by a financial institution. The plan must satisfy the irs
standards both in terms of the way it is designed and in the way it operates.

Question 15

If established correctly, a qualified plan will provide the following benefits

Answer 15

Employers may claim a tax deduction for all contributions that they make to a plan on their employees’ behalf; All contributions to the plan grow on a tax-deferred basis; Employees are not taxed on the amount they invest or on the gains generated from these investments in the plan until they begin taking distributions. Qualified plans are classified as either defined benefit or defined contribution plans.

Question 16

A defined benefit plan is a retirement plan designed to

Answer 16

provide employees with a fixed monthly payment at retirement, generally a percentage of the employee’s salary, as determined by such factors as the employee’s age, income level, and years of service. Must provide benefits, even if the plan’s investments perform below expectations

Question 17

Defined contribution plans are employer-sponsored retirement plans

Answer 17

where the retirement benefits depend on the amount contributed to the plan, plus any investment gains earned on those contributions. In defined contribution plans, each employee has a separate account within the plan-the more the employee and/or the employer contributes, the greater the eventual benefits. Some examples of qualified, defined contribution plans include profit-sharing plans, simplified employee pension (SEP) plans, and 401(k) plans.

Question 18

Profit-Sharing Plans

Answer 18

allow employees to patticipate in a company’s profits. The advantage of these plans for the employer is that it is not required to make a specific contrihution each year. If the company is not doing well, the employer may skip that year’s contribution entirely. However, if the company decides to contribute funds to the plan, the employer must allocate these funds to its employees in accordance with a predetermined formula. Generally, each participant receives a percentage of his salary. There are limitations on contributions. Employers may deduct contributions to the plan of up to 25% of an employee’s salaty, to a maximum of $52,000 per year.

Question 19

Money Purchase Plans

Answer 19

type of defined contribution retirement plan that employers may choose to offer. The employer’s contributions are based on a fixed percentage of the employee’s salaty. The employer must contribute this amount every year regardless of its profitability. If a contribution is missed, the employer is subject to irs penalties. The annual contribution limit is $52,000 and the plan requires that covered employees be vested immediately in the employer’s contributions.

Question 20

401 (k) plans are

Answer 20

a type of qualified plan that depends heavily on employee contributions. 401k plans allow employees to save a portion of their salary for retirement on a pretax basis. The earnings from their contributions grow on a tax-deferred basis until withdrawn by the employee. Employers may also choose to match a portion of their employees’ contributions. Employees are always fully vested in their own contributions, but employers may establish a vesting schedule for matching contributions. In most plans, the employees decide how to allocate their contributions from a menu of investment options selected by their employer.