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Retirement Planning & Employee Benefits > Pension Plans and Profit Sharing Plans (Lesson 2) > Flashcards

Pension Plans and Profit Sharing Plans (Lesson 2) Flashcards

1
Q

What are the 4 types of pension plans

A
  • Definied Benefit Pension Plan
  • Cash balance pension plan
  • Money purchase pension plan
  • Target benefit pension plans
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2
Q

What are the two types of defined benefit pension plans

A
  • Defined benefit pension plan
  • cash balance pension plan
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3
Q

What are the the two types of defined contribution pension plans

A
  • Money purchase pension plans
  • target benefit pension plan
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4
Q

What is commonly the benefit for a defined benefit plan

A
  • commonly based on a combination of the participants years of service with the company and the participants salary
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5
Q

What is the mandatory funding requirement for a defined benefit plan

A
  • helps ensure that the future benefits promised by the defined benefit formula in the plan document are sufficiently funded and that the employer only deducts the amount necessary to fund the future promised benefit
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6
Q

What is the mandatory funding requirement for a defined contribution plan

A
  • either a money purchase pension plan or a target benefit plan require that the plan sponsor fund the plan annually with an amount as defined in the plan document
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7
Q

What is a in service withdrawal

A
  • is any withdrawal from the plan while the employee is a participant in the plan other than a loan
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8
Q

When can a defined benefit pension plan provide for an service distributions

A
  • when participant is age 62 or older
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9
Q

How much of a pension plan be invested in employer securities

A

10%

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10
Q

What investment choices must a defined contribution plan offer

A
  • must allow the plan participants to diversify their pretax deferrals, after tax contributions, and employer contributions
  • employer must offer choice of at least three investment options other than employer securities
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11
Q

Which of the two test must a qualified plan pass in order if include life insurance

A
  • 25% test
  • 100 to 1 ratio
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12
Q

What is the 25% test

A
  • consists of two tests a 25% test and a 50% test
  • if term insurance is purchased the aggregated premiums paid for the life insurance cannot exceed 25% of the employers aggregated contributions to the participants account
  • if whole life is purchase the aggregated premiums paid cannot exceed 50% of the employers aggregate contributions to the participants account
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13
Q

What is the 100 to 1 ratio test for life insurance in a qualified plan

A
  • limits the amount of the death benefit of life insurance coverage purchased to 100 times the monthly accrued retirement benefit provided under the same qualified plans defined benefit formula
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14
Q

Does a defined benefit or defined contribution require an actuary

A
  • Defined benefit plan requires an actuary to determine the proper funding on the plan
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15
Q

Which defined contribution plan uses the services of an actuary

A
  • Target benefit plan uses an actuary at the inception of the plan and then they are not required
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16
Q

Does a money purchase pension plan need an actuary

A
  • no because plan contributions are predefined in the plan documents
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17
Q

Do defined benefit pension plans or defined contribution plans use commingled investment accounts

A
  • Defined benefit pension plans use commingled investment accounts but send individual summaries to participants
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18
Q

Who bears the investment risk in a defined benefit plan

A
  • plan sponsor bears the investment risk
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19
Q

Who bears the investment risk in a defined contribution plan

A
  • individual plan participant generally maintains their own account and bears the risk of investment
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20
Q

How are forfeitures allocated in a defined benefit pension plan

A
  • forfeited funds can only be used to reduce plan costs for the employer
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21
Q

How are forfeitures allocated in a defined contribution pension plan

A

Can be used in two ways:

  • to reduce future plan costs or
  • can be allocated to other remaining participants in a nondiscriminatory manner
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22
Q

Which plan does a Pension Benefit Guaranty Corporation insurance insure

A
  • defined benefit pension plan
  • insurance will pay a limited retirement benefit in the event of a plan completely or partially terminating
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23
Q

Which plans does a PBGC not insure

A
  • defined contribution pension plans
  • profit sharing plans
  • defined benefit pension plans of professional service corporations with 25 or fewer participants
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24
Q

What is the accrued benefit for a defined benefit plan

A
  • benefit is the actuarial equivalent of the benefit that would have been provided to the participant had the participant waited until retirement to receive the payments
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25
Q

What is the accrued benefit for a defined contribution plan

A
  • equal to the account balance of the qualified plan consisting of any combination of employer and employee contributions plus the earnings on the respective contributions reduced by any non vested amounts
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26
Q

What does credit for prior services mean

A
  • a defined benefit plan may elect to give employees credit for their service prior to the establishment of the plan
  • employee will receive accrued benefits in a DB plan based on their service prior to the start of the DB plan
  • Must be nondiscriminatory but may benefit an older owner employer who does not have many long term employees
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27
Q

Can a defined contribution plan grant credit for prior service

A

No

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28
Q

What is social security integration

A
  • Also known as Permitted disparity
  • allows a higher contribution or allocation of benefits to employees whose compensation exceeds the SS wage base for the plan year
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29
Q

What are the two methods of permitted disparity

A
  • offset method
  • excess method
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30
Q

Which plans can use social security integration

A
  • all qualified pension plans
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31
Q

Which social security integration method can defined contribution plans use

A
  • only the excess method
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32
Q

What is the excess method

A
  • provides an increasing percentage benefit to those plan participants whose earnings are in excess of an average of the SS wage base over the 35 year period prior to the individuals SS retirement age (called covered compensation limit)
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33
Q

What does the excess method percentage apply to

A

The increased percentage benefit only applies to income that exceeds the covered compensation limit and is limited to the lesser of:

  • 0.75% per year of service or
  • benefit percentage for earnings below the covered compensation limit per year of service
  • Only applies up to 35 years
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34
Q

What is the maximum increase in benefit under the excess method

A
  • 26.25% (or 0.75% times 35 years)
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35
Q

What is the offset method that is used for defined benefit pension plans

A
  • applies a benefit formula to all earnings and then reduces the benefit on earnings below the covered compensation limit
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36
Q

What is the reduction in benefit under the offset method

A

The reduction of the benefit is limited to the lesser of

  • 0.75% per year of service up to 35 years or
  • 50% of the overall benefit funding percentage per year of service

Total reduction is limited to 26.25 percent of earnings below the 35 year covered compensation limit

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37
Q

What is the maximum in reduction benefit under the offset method

A
  • 26.25 percent
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38
Q

Does a defined benefit plan maintain separate accounts for each participant

A
  • No they commingle assets
  • Assets are managed as a group and it is impossible to segregate any individual participants funds
  • benefits are paid from the pool of assets
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39
Q

Does a defined benefit or defined contribution plan benefit older participants

A
  • Defined benefit plans benefit older participants
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40
Q

(Defined Benefit Plan/Defined Contribution plan)

Actuary annually required

A

Defined Benefit Plan: Yes

Defined Contribution Plan: No (Target benefit just needs it at inception)

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41
Q

(Defined Benefit Plan/Defined Contribution plan)

Investment Risk burden by

A

Defined Benefit Plan: Employer

Defined Contribution Plan: Employee

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42
Q

(Defined Benefit Plan/Defined Contribution plan)

Treatment of Forfeitures

A

Defined Benefit Plan: Must reduce plan costs

Defined Contribution Plan: Reduce plan costs or allocate to other plan participants

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43
Q

(Defined Benefit Plan/Defined Contribution plan)

PBGC Insurance

A

Defined Benefit Plan: Yes

Defined Contribution Plan: No

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44
Q

(Defined Benefit Plan/Defined Contribution plan)

Credit for Prior Service

A

Defined Benefit Plan: Yes

Defined Contribution Plan: No

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45
Q

(Defined Benefit Plan/Defined Contribution plan)

Social Security Integration

A

Defined Benefit Plan: Offset or Excess

Defined Contribution Plan: Excess only

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46
Q

(Defined Benefit Plan/Defined Contribution plan)

Separate Investment Accounts

A

Defined Benefit Plan: No - Commingled

Defined Contribution Plan: Yes - Separate (Usually)

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47
Q

(Defined Benefit Plan/Defined Contribution plan)

Favors Younger/older

A

Defined Benefit Plan: Older

Defined Contribution Plan: Younger

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48
Q

What are the most common benefit formulas for a defined benefit pension plan

A
  • Flat amount formula
  • Flat percentage formula
  • Unit credit formula
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49
Q

What is the flat amount formula for a defined benefit pension plan

A
  • provides a flat amount per month
  • Not based on years of service with the employer or the participants salary
  • every ones benefit is the same
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50
Q

What is the flat percentage formula for a defined benefit pension plan

A
  • flat percentage of compensation usually the final salary or an average of the participants highest salaries
  • does not increase based on years of service
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51
Q

What is the unit credit formula for a defined benefit pension plan

A
  • utilizes both a participant years of service and salary to determine the benefit
  • provides a fixed percentage of a participants salary multiplied by the number of years the participant has been employed
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52
Q

What is a cash balance pension plan

A
  • is a qualified plan that consists of an individual account with guaranteed earnings attributable to the account
  • However the account that the employee sees is merely hypothetical account displaying hypothetical allocations and hypothetical earnings
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53
Q

What does the plan sponsor establish when a cash balance plan is created

A
  • develops a formula to fund the cash balance hypothetical allocation
  • formula consists of a pay credit and interest credit
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54
Q

Does a cash balance plan have separate accounts

A

No assets are commingled

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55
Q

Does a cash balance account benefit older or younger participants

A
  • generally more beneficial for younger participants because the formula is generally based on number of years the participant is employed by the plan sponsor
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56
Q

What vesting schedule must a cash balance plan us

A

3 year cliff

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57
Q

When does a cash balance plan conversion occur

A
  • when an employer changes from a traditional defined benefit pension plan into a cash balance plan
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58
Q

What are the three requirements a hybrid plan must meet

A
  • participants accrued benefit would be equal to or greater than that of any similarly situated younger participant
  • interest rate used to determine the interest credit on the account balance in the hybrid plan must not be greater than a market rate of return to be determined under regulations to be issued
  • plan years beginning after 2007 the hybrid plan must provide 100 percent vesting after 3 years of service
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59
Q

What is a money purchase pension plan

A
  • a defined contribution plan that provides for a contribution to the plan each year of a fixed percentage of the employees compensation
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60
Q

What does an employer promise with a Money purchase pension plans

A
  • to make a specified contribution to the plan for each plan but the employer is not required to guarantee a specific retirement benefit
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61
Q

What is the contribution limit for a money purchase pension plan

A
  • limited to contributing on behalf of each participant the lesser of 100% of the participants compensation or $58,000
  • Employer cannot deduct contributions to the plan in excess of 25% of the employers total covered compensation
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62
Q

Does a money purchase pension plan maintain separate accounts

A
  • yes each participant has their own account
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63
Q

Does a money purchase pension plan benefit younger or older participants

A
  • benefit younger participants because of the increased number of contributions and compounding periods
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64
Q

What vesting schedule does a money purchase pension plan use

A
  • 2 to 6 year graduated
  • 3 year cliff vesting
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65
Q

What is a target benefit pension plan

A
  • a special type of money purchase plan that determines the contribution to the participants account based on the benefit that will be paid from the plan at the participants retirement
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66
Q

Is a actuary required for a target benefit plan

A
  • yes at the establishment of the plan but not required on an annual basis
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67
Q

What is a profit sharing plan

A
  • is a plan established and maintained by an employer to provide the participant in profits by employees or their beneficiaries
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68
Q

What are the 7 types of profit sharing plans

A
  • Profit sharing plans
  • Stock bonus plans
  • ESOP
  • 401k plans
  • Thrift plans
  • Age based profit sharing plan
  • new comparability plan
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69
Q

(Pension plan and Profit Sharing Plan)

What are the legal promises of each

A

Pension Plan: Paying a pension at retirement

Profit sharing plan: Deferral of compensation and thus tax deferral

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70
Q

(Pension plan and Profit Sharing Plan)

Are in service withdrawals permitted

A

Pension Plan: No (59 1/2 or older)

Profit sharing plan: Yes after two years

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71
Q

(Pension plan and Profit Sharing Plan)

Is the plan subject to mandatory funding standards

A

Pension Plan: Yes

Profit sharing plan: No

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72
Q

(Pension plan and Profit Sharing Plan)

Percent of plan assets allowed to be invested in employer securities

A

Pension Plan: 10%

Profit sharing plan: 100%

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73
Q

(Pension plan and Profit Sharing Plan)

Employer annual contribution limit of covered compensation

A

Pension Plan: 25% (must meet minimum funding standards)

Profit sharing plan: 25%

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74
Q

Are there any funding requirements for a profit sharing plan

A
  • No but must be substantial and recurring
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75
Q

Do contributions to a profit sharing plan have to come from profits

A
  • No
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76
Q

When can a profit sharing plan be established in the year

A
  • can be established and funded as late as the federal income tax due date plan extensions
77
Q

What is the standard method for allocating contributions to a profit sharing plan

A
  • is to simply allocate the contribution based on a percentage of each employees compensation
78
Q

Who do profit sharing plans benefit the most

A
  • highly compensated employees because the contribution is based on a straight percentage of total covered compensation
79
Q

Which social security integration can a profit sharing plan use

A
  • excess method
80
Q

What is the excess rate limited to for a profit sharing plan

A
  • lesser of twice the base rate or a difference of 5.7%
  • excess rate is 5.7% higher than the base rate
81
Q

What is the formula for excess rate

A

(BP = Exxon)

Base rate + Permitted Disparity = Excess rate

82
Q

What is an age based profit sharing plan

A
  • uses both age and compensation as the basis for allocating contributions to an employee account
83
Q

When is a age based plan chosen

A
  • when the employee census is such that the owner or key employee is older than most or all other employees and the company wants to tilt the contribution toward those older employees
  • Actuary would allow for this tilting of contributions
84
Q

What is a new comparability plan

A
  • generally a profit sharing plan in which contributions are made to an employees account based on their respective classification in the company defined by the plan sponsor
85
Q

How must a new comparability plan and a age based profit sharing plan meet nondiscrimination rules

A
  • Must comply with the cross testing rules
  • cross testing rules dictate testing of defined contribution plans on the expected benefits to be received by employees at retirement
86
Q

How are forfeitures for a profit sharing plan allocated

A
  • may either be used to reduce plan contributions or
  • be reallocated to the remaining participants accounts
87
Q

How can forfeitures be allocated for a profit sharing plan

A
  • can be allocated based on current compensation
  • cannot be reallocated to participants accounts that have already reached their annual additions limit for the year
88
Q

What are the vesting rules for a profit sharing plan

A
  • same as for defined contribution plans
  • 3 year cliff or a 2 to 6 year graduated
  • unless a two year eligibility period is chosen in which case the employee is 100% vested in everything
89
Q

Do profit sharing plans permit in service withdrawals

A
  • yes after the participant has fulfilled two years of service in the plan
90
Q

What types of plans are permitted with a 401k plan

A
  • profit sharing plan
  • stock bonus plan
91
Q

How are employee contributions to a 401k treated

A
  • elective deferral contributions are tax deferred meaning the earnings are not subject to income taxation until such time as the employee takes a distribution from the plan
92
Q

Which type of entities can establish a 401k plan

A
  • corporations
  • partnerships
  • LLCs
  • Proprietorships
  • Tax exempt entities
93
Q

Can an employee be required to complete more than one year of service as a condition of participation in a 401k plan

A
  • no they cannot
94
Q

How are employer matching contributions vested in a 401k plan

A
  • must vest under a schedule at least as generous as the 2 to 6 year graduated or 3 year cliff schedules
95
Q

What is the employee elective deferral amount and catchup amount

A
  • $19,500
  • $6,500 catch up for 50 or older
96
Q

What are thrift plans

A
  • allow employees to make after tax contributions
  • utilized by individuals who want to save more than the elective deferral limit or more than the amount allowed under the ADP/ACP test
97
Q

(Roth IRA vs Roth 401k)

Contribution limit

A

Roth IRA: $6000

Roth 401(k): $19500

98
Q

(Roth IRA vs Roth 401k)

Catch up contribution limit

A

Roth IRA: $1000

Roth 401(k): $6500

99
Q

(Roth IRA vs Roth 401k)

Income Limit

A

Roth IRA: Modified AGI

  • MFJ: $198,000 - $208,000
  • Single: $125,000 - $140,000
  • MFS: $0-$10,000

Roth 401(k): No income deferrals

100
Q

(Roth IRA vs Roth 401k)

Conversion from a traditional IRA account allowed

A

Roth IRA: Yes

Roth 401(k): No

101
Q

(Roth IRA vs Roth 401k)

Available for loans

A

Roth IRA: No

Roth 401(k): Yes

102
Q

(Roth IRA vs Roth 401k)

Qualified distributions (not subject to tax or penalty)

A

Roth IRA: Held at least 5 years and made for first time home purchase, disability, death, or on or after the attainment of age 59 1/2

Roth 401(k): held for at least 5 years and distribution must be made because of disability, death, or on or after the attainment of age 59 1/2

103
Q

(Roth IRA vs Roth 401k)

Distributions that are not qualified

A

Roth IRA: First Contributions, Second Conversions, Third Earnings

Roth 401(k): Determined under Section 72. Each distribution is part earnings/basis

104
Q

(Roth IRA vs Roth 401k)

Required Distributions

A

Roth IRA: No RMDs

Roth 401(k): Follows normal RMD rules

105
Q

When must matching contributions vest under a 401k plan

A

at least as rapidly as either

  • 3 year cliff
  • 2 to 6 year graduated vesting schedule
106
Q

Do employee elective deferral contributions count against the plan contribution limit of 25%

A
  • do not count against the plan contribution limit of 25%
  • still limited to $58,000 though
107
Q

Are catchup plan contributions limited by the 25% of employee compensation

A
  • no
108
Q

What two additional nondiscrimination tests must a CODA (401k) plan meet

A
  • Actual Deferral Percentage (ADP)
  • Actual Contribution Percentage (ACP)
109
Q

What are the three options with respect to a 401k nondiscrimination testing

A
  • Perform the ADP and ACP test and take corrective action if the plan fails the test
  • Institute a qualified automatic enrollment feature and comply with the new safe harbor or
  • comply with the old safe harbor
110
Q

What does the Actual Deferral Percentage (ADP) Test

A
  • is designed to test the elective deferrals of the employees to ensure that the nonhighly compensated employees are not being financially discriminated against
111
Q

(ADP Test)

If the ADP for NHC employees is: 0% to 2%

A
  • The Permissible ADP for HC Employee is:

2 times ADP for NHCs

112
Q

(ADP Test)

If the ADP for NHC employees is: 2% to 8%

A
  • The Permissible ADP for HC Employee is:

2% plus ADP for NHCs

113
Q

(ADP Test)

If the ADP for NHC employees is: 8% and over

A
  • The Permissible ADP for HC Employee is:
    1. 25 times ADP for NHCs
114
Q

What are the two methods that can be chosen for the ADP testing

A

Prior year method

  • calculates the maximum permissible deferral for highly compensated employees by using the nonhighly compensated employees ADP from the previous year

Current year method

  • usually provide a greater deferral percentage to the HC and provides more flexibility to the plan sponsor in the event of a ADP failure
115
Q

How is the ADP calculated

A
  • separate the eligible employees into HC and NHC groups
  • calculate the actual elective deferral ratio (ADR) for each of the eligible employees by dividing the elective deferral contribution by the employees compensation
  • once ADR is determined for each eligible employee, the amount of the ADP is calculated by averaging the ADRs for the employees within each group (HC or NHC)
  • Plug the ADP for the NHC into the chart and calculate the maximum ADP allowed for the HC
  • Compare the desired/required ADP to your actual ADP. If the HC are higher, employer failed the ADP test
116
Q

What are the four corrective actions that a plan can take to correct failing an ADP or ACP test

A
  • Corrective distributions
  • recharacterization
  • qualified non elective contributions (QNEC) or
  • qualified matching contributions (QMC)
117
Q

What is a corrective distribution that is made when a plan fails the ADP or ACP test

A
  • Easiest way and usually the cheapest
  • reduces the elective deferrals of the HCs by distributing or returning funds to the HCs
  • Any earnings on the returned contributions must also be returned or distributed to the HC employees
  • must be completed within 2 1/2 months after the end of the plan year otherwise a 10% excise tax is imposed on the amount that should have been distributed
118
Q

How long does a plan sponsor have to make a corrective distribution

A
  • completed within 2 1/2 months after the end of the plan year or a 10% excise tax is imposed on the amount that should have been distributed
119
Q

What is a recharacterization that is done when a plan fails the ADP or ACP

A
  • the excess deferrals (pretax) are recharacterized to after tax employee contributions
  • May cause a problem for the plans ACP test
120
Q

When must recharacterization be completed by

A
  • within 2 1/2 months after the end of the plan year at which time these recharacterized contributions are taxable to the employee
  • 10% excise penalty on the amount of excess contribution
121
Q

What is a the qualified non elective contribution (QNEC) that is made when a plan fails the ADP or ACP test

A
  • Employer can make a QNEC to all eligible NHC employees CODA accounts to increase the ADP of the NHC employees for purposes of passing the ADP test
  • made to all NHC employee covered by the plan without considering the employees election to participate by electively deferring
  • Employee is 100% vested in the contributions
122
Q

What is a the qualified matching contribution (QMC) that is made when a plan fails the ADP or ACP test

A
  • a contribution made by the plan sponsor that increases the ADP of the NHC employees
  • only made to those eligible NHC employees who participated in the plan during the plan year
  • Employee is 100% vested in the contributions
123
Q

What is the Actual Contribution Percentage (ACP)

A
  • calculates a contribution percentage for both HC and the NHC for the express purpose of determining if the NHC are subject to financial discrimination
  • the sum of the employees after tax contributions and employer matching contributions
124
Q

What is the safe harbor method used for 401k plans

A
  • employer is not required to comply with the ADP, ACP, or top heavy testing
  • plan must provide a minimum contribution that must be immediately 100% vested
  • permissible contributions can either be a 3% minimum non elective contribution or a matching contribution
125
Q

What happens if the safe harbor election is made at least 30 days prior to the close of the plan year

A
  • Non elective contribution must be at least 4% for all eligible employees
  • plan must be amended no later than the last day for distributing excess contributions for the plan year
126
Q

What happens if the employer elects to use a match rather than the non elective contributions under a safe harbor 401k election

A
  • standard safe harbor match formula requires the employer to match 100% of the first 3% of employee elective deferrals and 50% of employee elective deferrals greater than the 3% and less than 5%
127
Q

(Safe Harbor Match for 401k Plans)

If the Employee elective deferral is the below what is the Employer safe harbor match percentage?

0%

1%

2%

3%

4%

5% or more -

A

Employer Safe Harbor match is:

0% - 0%

1% - 1%

2% - 2%

3% - 3%

4% - 3.5%

5% or more - 4%

128
Q

What is a automatic enrollment or negative election feature for a Safe Harbor 401k plan

A
  • provides that elective contributions by the employee are made at a specified rate unless the employee elects otherwise
  • Employee though must have a effective opportunity to elect to receive taxable wages in lieu of contributions
129
Q

What requirements must a automatic enrollment feature meet with respect to

A
  • automatic deferral
  • matching or non elective contributions and
  • notice to employees
130
Q

How does a plan satisfy the automatic deferral requirement

A
  • unless an employee elects otherwise the employee is treated as making an election to make elective deferrals equal to a stated percentage of compensation not in excess of 15% after the first year and at least equal to the below:

First year - 3%

Second year - 4%

Third year - 5%

4th and after - 6%

131
Q

How is the automatic deferral requirement applied to employees

A
  • uniformly to all eligible employees
132
Q

What is the matching contribution requirement under a qualified automatic enrollment feature

A
  • must provide a contribution of 3% or

A matching contribution equal to the below:

  • must vest no later than a two year cliff vesting
  • make a contribution to each NHC that equals 100% of employee deferrals up to 1% of compensation and 50% of employees deferrals between 1% and 6% of compensation
133
Q

Under a negative election are they required to be 100% immediate vesting

A
  • No but all employee contributions are 100% vested
134
Q

How much of a loan can a qualified plan permit

A
  • lesser of one half of the vested plan accrued benefit up to $50,000
  • If vested balance is less than or equal to $20,000 then a loan up to the greater of $10,000 or the vested accrued benefit
135
Q

When must qualified plan loans be repaid

A
  • within 5 years unless used for a principal residence then could be as long as 30 years
136
Q

What happens if a loan is not repaid from a qualified plan

A
  • will result in the loan being treated as a distribution as of the date of the original loan
137
Q

All CODA type plans distributions may occur after

A
  • retirement, death, or separation of service of the participant and attainment of age 55
  • Termination of the plan without the establishment of another plan
  • certain acquisitions of the company or company assets
  • attainment of age 59 1/2 by the participant or
  • certain hardships
138
Q

What is a stock bonus plan

A
  • is a defined contribution plan established and maintained by an employer to provide benefits similar to those of a profit sharing plan except that contributions to and distributions from a stock bonus plan are generally in the form of employer stock
139
Q

What is a Employee Stock Ownership Plan (ESOP)

A
  • is a qualified plan that invests primarily in qualifying employer securities typically shares of stock in the corporation creating the plan
140
Q

What requirements must a Stock bonus plan satisfy

A
  • must pass through voting rights on employer stock held by the plan
  • must have the right to demand employer securities on plan distributions
  • participants must have the right to demand that the employer repurchase the employers securities if they are not publicly traded
  • distributions must begin within one year of normal age, death, or disability
  • within five years for other modes of employment termination
  • Distributions must be fully paid within 5 years of commencement of distributions
141
Q

What are the advantages to the employee for a stock bonus plan

A
  • Employers reduced cash outlay may encourage regular contributions
  • employees efforts may be rewarded at retirement by increased stock value
  • Eligible for preferred net unrealized appreciation (NUA) tax treatment on lump sum distributions of employer stock
142
Q

What are the advantages to the employer for a stock bonus plan

A
  • FMV of contributions of employer stock are tax deductible to the employer, which can result in decreased income tax costs for the corporation with no cash outlay
  • Employees now share a vested interest in the success of the company which irrevocably binds their financial well being to the employers
143
Q

What are the disadvantages to the employee for a stock bonus plan

A
  • the risk associated with non diversified investment portfolio of employer stock
144
Q

What are the disadvantages to the employer for a stock bonus plan

A
  • ownership and control of the corporation is diminished or diluted
  • the required repurchase option could deplete the cash of the corporation
145
Q

Do stock bonus plans have to pass the eligibility, coverage, vesting, and ADP/ACP requirements that profit sharing plans have too

A

Yes

146
Q

(Stock bonus plans/Profit Sharing Plans)

Plan Establishment

A

Stock Bonus Plans: Due date of tax return plus extension

Profit Sharing Plans: Due date of tax return plus extension

147
Q

(Stock bonus plans/Profit Sharing Plans)

Date of Contribution

A

Stock Bonus Plans: Due date of tax return plus extension

Profit Sharing Plans: Due date of tax return plus extension

148
Q

(Stock bonus plans/Profit Sharing Plans)

Type of Contributions

A

Stock Bonus Plans: Generally Stock

Profit Sharing Plans: Generally Cash

149
Q

(Stock bonus plans/Profit Sharing Plans)

Deductible Contribution Limit

A

Stock Bonus Plans: 25% of Covered Compensation

Profit Sharing Plans: 25% of Covered Compensation

150
Q

(Stock bonus plans/Profit Sharing Plans)

Valuation

A

Stock Bonus Plans: Needed Annually

Profit Sharing Plans: Unnecessary

151
Q

(Stock bonus plans/Profit Sharing Plans)

Eligibility

A

Stock Bonus Plans: Same as qualified plans (age 21 and 1 year of service or 2 year w/ 100% vesting)

Profit Sharing Plans: Same as qualified plans (age 21 and 1 year of service or 2 year w/ 100% vesting)

152
Q

(Stock bonus plans/Profit Sharing Plans)

Allocation Method

A

Stock Bonus Plans: % of compensation or formula based on age, service of classification

Profit Sharing Plans: % of compensation or formula based on age, service of classification

153
Q

(Stock bonus plans/Profit Sharing Plans)

Vesting

A

Stock Bonus Plans: Same as defined contribution qualified plan (3 Year Cliff or 2 to 6 year Graduated)

Profit Sharing Plans: Same as defined contribution qualified plan (3 Year Cliff or 2 to 6 year Graduated)

154
Q

(Stock bonus plans/Profit Sharing Plans)

Portfolio Diversification

A

Stock Bonus Plans: No

Profit Sharing Plans: Yes

155
Q

(Stock bonus plans/Profit Sharing Plans)

Voting Rights

A

Stock Bonus Plans: Yes

Profit Sharing Plans: No

156
Q

(Stock bonus plans/Profit Sharing Plans)

Type of Distribution

A

Stock Bonus Plans: Stock

Profit Sharing Plans: Cash

157
Q

(Stock bonus plans/Profit Sharing Plans)

In Service Withdrawals

A

Stock Bonus Plans: allowed after two years

Profit Sharing Plans: allowed after two years

158
Q

(Stock bonus plans/Profit Sharing Plans)

Loans

A

Stock Bonus Plans: May be allowed but not usually

Profit Sharing Plans: May be allowed but not usually

159
Q

(Stock bonus plans/Profit Sharing Plans)

Taxation of Distributions

A

Stock Bonus Plans: Lump sum will qualify for NUA. Other distributions treated as ordinary income

Profit Sharing Plans: Full distribution is ordinary income

160
Q

What is a Employee Stock Ownership Plan

A
  • ESOPs are a special form of stock bonus plan that reward employees with both ownership in the corporation and provide owners with substantial tax advantages
161
Q

How is a ESOP setup

A
  • ESOP is controlled through a trust
  • Sponsor company receives a tax deduction for contributions of stock from the corporation
  • ESOP then allocates the stock to separate accounts for the benefit of the individual employee participants
162
Q

What is a LESOP

A
  • a leveraged ESOP plan
  • trust borrows money from a bank to purchase the employer stock
  • corporation then repays the loan through tax deductible contributions to the ESOP
  • both interest and the principal repayments for the loan are income tax deductible
163
Q

How does a closely held business qualify for nonrecognition of gain treatment for a ESOP

A
  • ESOP must own at least 30% of the corporations stock immediately after the sale
  • seller or sellers must reinvest the proceeds from the sale into qualified replacement securities (QRS) within 12 months after the sale and hold such securities three years (QRS are securities in a domestic corporation including stocks, bonds, debentures, or warrants which receive no more than 25% of their income from passive investments)
  • Corporation that establishes the ESOP must have no class of stock outstanding that is tradable on an established securities market
  • Sellers, relatives of seller, and 25% shareholders in the corporation are precluded from receiving allocations of stock acquired by the ESOP through rollover
  • ESOP may not sell the stock acquired through the rollover transaction for three years
  • Stock sold to the ESOP must be common or convertible preferred stock and must have been owned by the seller for at least three years prior to sale
  • If all of the above conditions are met no gain will be recognized
164
Q

What are the advantages to the Employer for a ESOP

A
  • Shareholder is often the owner who is looking to retire (selling shares to the plan and defer income tax consequences)
  • Without a ESOP there may not be a market for the privately held corporate stock
  • Corporation or trust is allowed to borrow money in order to provide contributions resulting in funds being provided immediately to the ESOP while the employer repays the loan to the ESOP with tax deductible contributions
165
Q

What are the advantages to the Employees for a ESOP plan

A
  • ESOP provides them with a type of retirement vehicle as well as ownership in their employer
  • Provides a vehicle to acquire the business which creates job preservation
  • can use NUA at the time of stock distribution
166
Q

What are the disadvantages to the Employees for a ESOP plan

A
  • lack of diversification in the plan
  • once employee reaches age 55 and 10 years of service the employer must offer some diversification options
167
Q

What are the disadvantages to the Employers for a ESOP plan

A
  • ESOPs dilute ownership in the corporation
  • the repurchase option for stock can create cash flow problems and administrative concerns
  • Administration is costly and the annual appraisals create significant and recurring expenses
168
Q

Do ESOP participants have the same voting rights with their allocated shares as other shareholders

A

Yes

169
Q

Are contributions to a ESOP plan deductible to the employer and are they subject to limitations

A
  • Yes and are subject to 25% limit of covered compensation
  • if a LESOP plan is being used the interest deduction is unlimited
170
Q

When are valuations required of employer stock in an ESOP

A
  • When contributions are made
  • lender must know the value of the stock to determine if and how much money to lend the corporation
  • if an employee exercises the put or repurchase option
  • needed for financial statements and reports
171
Q

How much employer stock is an ESOP able to hold

A

100%

172
Q

When is the employee allowed to use the forced diversification requirement in an ESOP

A
  • when they are at least age 55 and have completed 10 years of participation in the ESOP
173
Q

What is the forced diversification requirement that is available to employees who participate in a ESOP

A
  • qualified participant must be offered a diversification election within 90 days after the close of each plan year beginning with the year after the employee becomes qualified
  • may elect up to 25% of the account balance into one of the plans alternative investment options
  • after 6 years the percentage increases to 50%
174
Q

What happens if the employers securities are not readily tradable on an established market when a participant has a right to demand a distribution from a ESOP

A
  • participant has the right to require that the employer repurchase the employer securities under a fair market valuation formula
  • referred to as a put option or repurchase option
175
Q

(Stock Bonus Plan and ESOPs)

Plan Establishment

A

Stock Bonus Plan: Due date of tax return plus extensions

ESOP: Due date of tax return plus extensions

176
Q

(Stock Bonus Plan and ESOPs)

Date of Contribution

A

Stock Bonus Plan: Due date of tax return plus extensions

ESOP: Due date of tax return plus extensions

177
Q

(Stock Bonus Plan and ESOPs)

Type of Contribution

A

Stock Bonus Plan: Stock

ESOP: Stock

178
Q

(Stock Bonus Plan and ESOPs)

Deductible Contribution limit

A

Stock Bonus Plan:25% of covered compensation

ESOP: 25% of covered compensation plus interest paid on loan for a LESOP

179
Q

(Stock Bonus Plan and ESOPs)

Valuation

A

Stock Bonus Plan: needed

ESOP: needed plus dividends

180
Q

(Stock Bonus Plan and ESOPs)

Eligibility

A

Stock Bonus Plan: 21 and 1 year or 2 year with 100% vesting

ESOP: 21 and 1 year or 2 year with 100% vesting

181
Q

(Stock Bonus Plan and ESOPs)

Allocation Method

A

Stock Bonus Plan: % of compensation or formula based on age, service of classification

ESOP: % of compensation or formula based on age, service of classification

182
Q

(Stock Bonus Plan and ESOPs)

Integration with Social Security

A

Stock Bonus Plan: Yes

ESOP: No

183
Q

(Stock Bonus Plan and ESOPs)

Vesting

A

Stock Bonus Plan: 3 year cliff or 2 to 6 year graduated

ESOP: 3 year cliff or 2 to 6 year graduated

184
Q

(Stock Bonus Plan and ESOPs)

Portfolio Diversification

A

Stock Bonus Plan: No

ESOP: No

185
Q

(Stock Bonus Plan and ESOPs)

Voting Rights

A

Stock Bonus Plan: Yes

ESOP: Yes

186
Q

(Stock Bonus Plan and ESOPs)

Distribution form

A

Stock Bonus Plan: Stock

ESOP: Stock

187
Q

(Stock Bonus Plan and ESOPs)

In Service Withdrawals

A

Stock Bonus Plan: may be allowed after two years of participation

ESOP: may be allowed after two years of participation

188
Q

(Stock Bonus Plan and ESOPs)

Loans

A

Stock Bonus Plan: May be allowed

ESOP: May be allowed

189
Q

(Stock Bonus Plan and ESOPs)

Taxation of Distribution

A

Stock Bonus Plan: Ordinary income with NUA treatment available

ESOP: Ordinary income with NUA treatment available

Retirement Planning & Employee Benefits (5 decks)

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