Chapter 3: Profit sharing & 401(k) plans

Question 1

Difference between profit sharing and a pension plan?

3.1

Answer 1

Contributions are not mandatory

Question 2

Who contributes to a traditional profit-sharing plan?

3.1

Answer 2

Employers only

Question 3

What is a traditional profit-sharing plan?

3.1

Answer 3

Qualified defined contribution plan Nondiscriminatory Contributions are not mandatory—but there needs to be “substantial” and recurring contributions

Question 4

What are the limits of profit-sharing contribution plans?

3.1

Answer 4

$58k or 100% of income

Question 5

What are in-service distributions in profit-sharing plans?

3.1

Answer 5

Only allowed to take from profit-sharing defined controbution plans

Two tests must be satisfied to take distributions:

1. Hardship (immediate and heavy need)
2. Approved reason like

• Unreimbursed med expenses
• Buy a primary residence
• Prevent foreclosure
• College expenses

Question 6

How are hardship withdrawals from profit-sharing plans taxed?

3.1

Answer 6

• taxed as ordinary income
• If it’s for education—10% penalty
• If it’s for a home—10% penalty
• Medical expenses don’t have a penalty above 10% of AGI

Question 7

When do you use a profit-sharing plan?

3.1

Answer 7

• When you want to motivate employees.
• When profits fluctuate.

Question 8

What is an age-based profit-sharing plan?

3.2

Answer 8

Allocations adjusted based on age

Question 9

What is an age-based profit-sharing plan?

3.2

Answer 9

Allocations adjusted based on age

Question 10

What is a new comparability plan?

3.2

Answer 10

Employees are divided into classes like job category, age, years of service. Each class recieves a different employer contribution

Great for when there is a young owner and an older owner. Owners get equal contributions.

These plans must satisfy these rules:

1. At least 5% allocation to non-HCEs
2. Minimum allocation for non-HCEs must be 1/3rd of the highest allocation rate

Question 11

What are Stock bonus plans?

3.3

Answer 11

Profit-sharing plan

Employer is contributing stock rather than cash

Question 12

What is Net Unrealized Appreciation? 3.3

Answer 12

NUA is always taxed as LTCG

Question 13

What are ESOP Plans?

3.3

Answer 13

Type of stock bonus plan NUA advantages

Best when:

• Employer wants to make the employees owners of the business through tax-advantaged and low cost
• Employer wants to create a way for the company to borrow money
• owner wants to engage in estate and financial planning that creates a market for the stock
• employer doesn’t mind having additional shareholders

Question 14

What is a LESOP?

3.3

Answer 14

Leveraged Employer Stock Ownership Plan– An ESOP with a loan

Question 15

What are the types of 401K plans?

3.3

Answer 15

Traditional 401(k)

Safe Harbor 401(k)

SIMPLE 401(k)

Roth 401(k)

One participant (solo) 401(k)

Question 16

What are the features of a traditional 401(k)?

3.3

Answer 16

• CODA
• Contributions are limited to $19.5k
• Salary deferral
• Must pass general non discrimination test
• Must also pass ADP and ACP tests

Question 17

When are 401(k) plans chosen?

Answer 17

When the employer wants to encourage employees to save for themselves. Works best for younger people

Question 18

How is the ADP test calculated?

3.3

Answer 18

Actual Deferral Percentage

Looks at what the employees put into the 401(k)

Question 19

How is the ACP test calculated?

3.3

Answer 19

Includes the employee contributions and employer contributions.

Question 20

What happens if the ADP or ACP test fail?

3.3

Answer 20

Two options:

1. HCEs get their contributions back
2. Company can make additional matching contributions to non-HCEs to meet the ADP/ACP rules (QMAC or QNECs)

Question 21

What is automatic enrollment in traditional section 401(k) plans?

3.3

Answer 21

The employer is allowed to automatically enroll their employees.

You must agree to provide prescribed

Must have the opt-out notice

Question 22

What is a Safe Harbor 401(k)?

3.3

Answer 22

More simple than a traditional

Don’t have to do non-discrimination testing (deemed to have already met ADP and ACP test)

Still subject to top heavy rules

Has a mandatory employer contribution that is either:

1. 3% for all employees
2. Matching contribution 100% on first 3% of non-HCE comp AND 50% match on next 2%

Government orgs can’t use it

Question 23

Who can setup a SIMPLE 401(k)?

3.3

Answer 23

Employers with 100 or fewer employees that are earning at least $5k per year.

Question 24

What are benefits of SIMPLE 401(k)?

3.3

Answer 24

Easier/cheaper to setup

No nondiscrimination test

No ADP test

Question 25

What are SIMPLE 401(k) employee contribution limits?

3.3

Answer 25

$13500

Question 26

What are employer requirements in a SIMPLE 401(k)?

3.3

Answer 26

Must match elective deferrals up to 3% of the employee comp OR

make nonelective contributions of 2% of comp for all employees, even if the employee chooses not to make an elective deferral

No vesting—all employees are immediately 100% vested.

Question 27

What is a Roth 401(k)?

3.3

Answer 27

A 401(k) that allows for Roth deferrals

Question 28

What are the requirements for a stock bonus plan?

3.3

Answer 28

• taxation on LTCG may be deferred past distribution date
• Allows for flexible employer contributions
• Allows social security integration
• If the stock is not tradable, a participant who separates from service must be provided a put option

Question 29

What are cross-tested plans?

Answer 29

Designed to slant employer contributions in favor of older, higher-paid employees.

• New comparability plans
• Age-based profit sharing plans

Question 30

What is a keogh (self employed) plan?

Answer 30

Employer sponsored that covers one or more self employed individuals

Can be a DB, DC or tax advantaged

Typically a profit sharing, money purchase, or target benefit

Question 31

How is the net contribution rate for a Keogh determined?

Answer 31

Divide the contribution percentage by 1+ the contribution percentage.

ex: If company contribution is 25%–.25/1.25 = 20%

if company contribution is 15% –.15/1.15 = 13.04

Question 32

How do you calculate a Keogh deduction?

Answer 32

1. Determine net income
2. Subtract deductible amount of SE tax paid
3. Multiple by net contribution rate