Chapter 3: Qualified Plan Overview Flashcards
Qualified Plan
Must follow a standard set of rules and requirements to attain “qualified” status us IRC 401a.
Covered Compensation amount
$330,000
Defined Benefit Maximum Limit
$265,000
Defined Contribution Maximum Limit Amount
$66,000
401(k) Plan Deferral Limit
$22,500
Highly Compensated Employee Amount
$150,000
Key Employee
$215,000
Social Security Wage Base
$160,200
The 4 types of Pension Plans
- Defined Benefit Pension Plan
- Cash Balance Pension Plan
- Money Purchase Pension Plan
- Target Benefit Pension Plan
Which two Pension Plans are also Defined Benefit Pension Plans?
- Defined Benefit Pension Plan
- Cash Balance Pension Plan
Which two Pension Plans are Defined Contribution Pension Plans?
- Money Purchase Pension Plan
- Target Benefit Pension Plan
The 7 types of Profit-Sharing Plans
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- Profit-Sharing Plans
- Stock Bonus Plans
- 401(k) Plans
- Employee Stock Ownership Plans (ESOPs)
- Thrift Plans
- New Comparability Plans
- Age-Based Profit-Sharing Plans
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What is the “Legal Promise” of a Pension Plan?
To Pay a Pension at Retirement
What is the “Legal Promise” of a Profit-Sharing Plan?
To Defer compensation and taxation to a future date.
Are in-service withdrawals permitted on Pension Plans?
No
Are in-service withdrawals permitted on Profit-Sharing Plans?
Yes after two years if the plan permits
Are Pension Plans subject to mandatory funding standards?
Yes
Are Profit-Sharing Plans subject to mandatory funding standards?
No
What percent of plan assets can be invested in employer securities inside a Pension Plan?
10%
What percent of plan assets can be invested in employer securities inside a Profit-Sharing Plan?
up to 100%
Must a Pension Plan provide qualified joint and survivor annuity and a qualified preretirement survivor annuity?
Yes
Must a Profit-Sharing Plan provide qualified joint and survivor annuity and a qualified preretirement survivor annuity?
No
Define Pension Plan
A plan established and maintained by an employer to provide systematic benefits to employees over a period of years, usually life after retirement.
In a Pension Plan how are benefits measured?
- years of service and
- compensation received.
Define a Profit-Sharing plan
a plan established by an employer so employees may be able to participate in the company’s profits.
Define a Defined Contribution Plan
A plan which provides an individual account for each participant and for benefits, solely based on the amount contributed to the participants account.
Define a Defined Benefit Plan
Any plan which is not a defined contribution plan.
What is the Annual Contribution Limit of a Defined Benefit Plan?
The greater of
1) the sum of the plan’s funding target, target normal cost, and a cushion amount over the value of the plan assets, or
2) the minimum required contribution for the plan year.
What is the Annual Contribution Limit of a Defined Contribution Plan?
25% of covered compensation
In a Defined Benefit Plan who assumes the investment risk?
employer
In a Defined Contribution Plan who assumes the investment risk?
Employee
How are Forfeitures handled in a Defined Benefit Plan?
Reduce Plan Costs
How are Forfeitures allocated in a Defined Contribution Plan?
Reduce Plan Costs or Allocate to other participant’s accounts
Are Defined Benefit Plans subject to Pension Benefit Guaranty Corporation (PBGC) coverage?
Yes, except professional firms with less than 25 employees
Are Defined Contribution Plans subject to Pension Benefit Guaranty Corporation (PBGC) coverage?
No
Do Defined Benefit plans have separate investment accounts?
No, accounts are commingled.
Do Defined Contribution plans have separate investment accounts?
yes accounts are separate
Do Defined Benefit Plans provide credit for prior service for the purpose of benefits?
Yes
Do Defined Contribution Plans provide credit for prior service for the purpose of benefits?
No
The matching principal
In almost all cases in the field of income taxation, when one individual or entity has a tax deductible expense, another entity or individual will have taxable income.
Payroll Tax (OASDI)
6.2% on compensation up to $160,200 and 1.45% for Medicare on 100% of employee’s income.
Total 7.65%
Total Payroll Tax (OASDI) paid between employer and employee
12.4% on compensation up to $160,000 and 2.9% for Medicare on 100% of employee’s compensation.
Total15.3%
When an employer makes a contribution to a qualified plan on behalf of its employees, do they pay OASDI tax on that portion?
No, the employer’s contribution (such as Employer’s Match or Employer’s Profit-sharing Contribution) is not subject to payroll tax (OASDI) even though the contribution was on account of services rendered. This is known as the payroll tax exclusion.
When an employee makes an elective deferral of income into a qualified plan, is it subject to OASDI tax?
Yes. Therefore elective deferrals into 401(k), 403(b), SIMPLEs, SARSEPs, and 457 plans will be subject to OASDI tax.
Qualified Domestic Relations Order (QDRO)
A court order related to divorce, property settlement, or child support
ERISA
Employee Retirement Income and Security Act to provide protection for an employee’s retirement assets, both from creditors and from plan sponsors.
What does anti-alienation protect against?
prohibits any action that may cause the plan assets to be assigned, garnished, levied or subject to bankruptcy proceedings while the assets remain inside the qualified retirement plan.
What protections are excluded from anti-alienation?
Qualified Domestic Relations Orders (QDRO), Federal tax levy / lien, judgement or settlement rendered from a criminal act involving the same qualified plan.
What special taxation treatment are lump-sum distributions from qualified retirement plans eligible for?
Net Unrealized Appreciation (NUA) Treatment
which qualified plans are excluded from the special NUA taxation treatment for lump-sum distributions?
IRA, SEP IRA, and SIMPLE IRA.
Employer Advantages of Qualified Plans
- Employer Contributions are currently income tax deductible
- Employer Contributions to the plan are not subject to payroll taxes.
Employee Advantages of Qualified Plans
- Pre-tax contributions
- tax-deferral earnings
- ERISA protection
- Lump-Sum distributions may qualify for NUA tax treatment.
Disadvantages of Qualified Plans
- limited contributions amounts
- contributions cannot be made after money received.
- plans have limited investment options.
- no or limited access to money while actively employed
- distributions usually taxed as ordinary income.
- early withdrawal penalties
- mandatory distributions age 73
- only ownership permitted is individual.
- cannot assign account or pledge it as collateral
- limited enrollment periods.
- considered to be income with respect to decedent asset, subjecting distributions to both income and estate taxes with no step-up in basis.
- cost of plan operation.
Qualified Plan Standard Eligibility Requirements
- age 21 attained OR
- 1 year of service with work of at least 1,000 hours completed.
The Employer Elective Grace Period
Even if an employee meets the requirements for eligibility into sponsored retirement plan an employer can make the employee wait until the next plan entrance date, as long as the next entrance date is not more than 6 months after the date of eligibility.
Long-Term Part-Time Employee Eligibility into sponsored retirement plan
The SECURE Act Dec. 2019
amended eligibility requirements to allow long-term part-time employees who are age 21 and worked at least 500 hours/ year for the employer for 3 consecutive years to participate in sponsored retirement plan.
2 Year, 100% Participation Rule
When a employer’s sponsored retirement plan requires two years of work in order to be eligible to contribute, there will be 100% immediate vesting of the contribution.
2 Year, 100% Participation Rule not available for 401(k).
Special Sponsored Retirement Plan Eligibility Rules for Educational Institutions
tax-exempt educational institutions may delay eligibility into their sponsored retirement plan until the later of either
1) attained age of 26
OR
2) worked for one year
Qualified Plan Coverage Test
To be qualified the plan must meet one of 3 tests:
- General safe harbor test
- Ratio Percentage test
- Average benefits test
(Defined Benefit Plans are an exception. They must satisfy the 50/40 test)
Nonexcludable employees
Any employee who is covered under a qualified plan. This would exclude any person who
1. has not attained age 21
2. has not completed 1 year of work
3. foreigners who do not work in the US.
Nonexcludable employees are divided into two classifications:
- Non-Highly Compensated
- Highly Compensated
Define Highly Compensated Employee
Someone who is either:
1. 6% or more owner at any time during the plan year or preceding plan year
OR
2. an employee that earns $150,000 + for the prior year.
Attribution of Ownership Shares extends to family members such as
Spouse
Parents
Children Grandchildren
The General Safe Harbor Test Requirement
Requires the percentage of Non-Highly Compensated employees covered under the plan to be equal to or more than 70%.
The Ratio Test Requirement
Requires that
The Percentage of NHC emp. /
The Percentage od HC emp.
Is Equal to or More than 70%
The Average Benefits Test must satisfy two tests:
- The average benefits percentage test
- the nondiscriminatory classification test.
The Average Benefits Percentage Test
Average Benefit Percentage of NHC emp.
/
Average Benefit Percentage of HC emp.
= 70% or more
The Nondiscriminatory Classification Test
the method of choosing employee classifications to cover under a qualified plan must meet two requirements:
1. classification must be reasonable and established (hourly or salaried, geographic location…)
2. The classification must be nondiscriminatory
Defined Benefit Test
In order for the Defined Benefit Test to be Qualified it must Satisfy 2 tests:
1. 50/40 Test
AND
1 of the 3 other tests:
a. General Safe Harbor test
b. Ratio Percentage Test
c. Avg. Benefits Test
The 50/40 Test
Requires the Defined Benefit Plan to benefit the lesser of 50 non-excludable emp. or 40% of all non-excludable emp.
Cliff Vesting Sched.
employee fully vested after X years (usually 3 years)
Graduated Vesting Sched.
Gradually vested in greater percentages over time. for example, 2 to 6 year graded vesting.
Defined Contribution Plans vesting requirements
Must vest under 2 to 6 year graded vesting schedule or 3-year cliff schedule.
Defined Benefit Plan vesting requirements
Must vest under 3 to 7 year graded vesting schedule or 5-year cliff schedule.
Defined Benefit Plan vesting requirement exception when BD plan is Top Heavy
same minimum vesting requirements as Defined Contribution plans…
Must vest under 2 to 6 year graded vesting schedule or 3-year cliff schedule.
Cash Balance plans vesting requirements
3 year cliff schedule.
Top-Heavy requirements are most commonly applicable to who
- small employer plans
- age-based profit-sharing plans
- any other plan that provides owners and executives with a disproportionate level of benefits from the plan.
Top Heavy Defined Benefit Plan
when total accrued benefits of key emp. exceeds 60% of present value of total accrued benefits.
Top Heavy Defined Contribution Plan
when the aggregate of the account balanced of key emp. exceeds 60% of the aggregate of all accounts.
When a Qualified plan is found to be Top Heavy then
The plan must
1) use top heavy vesting schedules and
2) provide a minimum level of funding to non key employees.
Define Key Employee
an employee who meets 1 of the criteria:
1. 6% + owner
2. Greater than 1% owner with compensation in excess of $150,000
3. An officer with compensation in excess of $215,000 in previous year.
Top Heavy Vesting Schedules (2)
- 2- 6 year graded schedule
- 3-year cliff schedule.
Minimum funding for Top Heavy Defined Contribution Plans
must provide each of its non-excludable, non-key employees a contribution to at least 3% of the employees compensation.
(available to all except long-term part-timers)
Minimum funding for Top Heavy Defined Benefit Plans
The employer must provide nonkey employees with a benefit equal to 2% per years of service (limit 20%)
*
the employee’s
average annual compensation.
CODA plan must satisfy 2 Tests
- Actual Deferral Percentage (ADP) test
- Actual Contribution Percentage (ACP) test
