PS and DC Plans Flashcards
What type of plan is a profit-sharing plan?
Defined contribution - contributions are not required because it is not a pension plan. Contributions come from profits, retained income, etc.
What are the type of contributions that can be made to a profit-sharing plan?
In the name - profits (discretionary) and flexible annual (every 3 of 5 years) contributions
What is the saver’s credit?
A non-refundable tax credit for up to $2000 for those who contribute to their retirement account, reduced by distributions from that account.
Exceptions, full-time students, those claimed on another tax filing, and has a phase-out
What is a major advantage of any profit sharing plan?
In-service distributions. Most plans allow for hardship withdraws
Financial needs test: must be an immediate need
Resource test: participant must not have any other source to satisfy need
In addition to the hardship test, what are the only reasons an in-service withdraw would be allowed? (My disastrously faulty emergency fund)
Payment of unreimbursed medical expenses
Federal distasters
Purchase of primary home
Payment of higher education expenses
Payment necessary to prevent foreclosure
What is “My disastrously faulty emergency fund”?
M= medical
D= disaster
F= first home
E= education
F= foreclosure
What is the result of early or hardship withdrawals from non-qualified distributions?
A 10% penalty on top of the ordinary income tax paid. The exception is for amounts over the 7.5% of AGI for medical.
What are key characteristics of a profit sharing plan?
A DC plan, but not a pension plan - required contributions every 3 of 5 years
NOT covered by PBGC
Use when business has sporadic income
Use with a young workforce (time to save)
EEs take on the investment risk
What is an age-weighted profit sharing plan?
Still a contribution plan - example of a cross-tested plan.
Each participants compensation is weighted by an age factor, skewing older employees (usually the owner) to a higher contribution factor without breaking nondiscrimination rules. It is tested on benefits, not contributions, which gives flexibility.
Still limited to 100%/$61k contribution
What is a new comparability plan?
Another example of a cross-tested plan. Participants are divided into groups which can be based on a myriad of factors. Each group then gets a certain compensation benefit. Again, this does not break nondiscrimination if it satisfies 1 of 2 gateway rules:
-Each eligible non-HCE must receive 5%
-If not 5%, each non-HCE must receive at least 1/3 of the highest allocation compensation.
What is a stock bonus plan?
A type of profit-sharing defined contribution plan where the ER contributes stocks instead of cash
What is Net Unrealized Appreciation (NUA) and how is it taxed in a stock bonus plan?
NUA is the difference between cost basis and FMV at distribution. At distribution, the EE pays ordinary income tax on the basis. Upon selling stock, the EE pays long term capital gains on the NUA and depending on the holding period, either short or long term capital gains on any growth since distribution.
What is an employee stock ownership plan (ESOP)?
An employee benefit plan that gives workers ownership interest in the company in the form of shares of stock.
ESOPs encourage employees to give their all as the company’s success translates into financial rewards.
How does an EE “cash out” of an ESOP?
When a fully vested employee retires or resigns from the company, the firm “purchases” the vested shares back from them. The money goes to the employee in a lump sum or equal periodic payments, depending on the plan.
Once the company purchases the shares and pays the employee, the company redistributes or voids the shares. Employees who leave the company voluntarily cannot take the shares of stock with them, only the cash payment.
What are disadvantages of an ESOP?
Cannot be integrated with SS
Lack of diversification (if this is all the EE has)
What is a LESOP? (leveraged)
An ESOP that has bought out its owner’s shares using a loan and the ERs shares as collateral. The payment of that loan then frees up additional shares to contribute to EEs
What are the four types of 401(k) plans?
Traditional
SIMPLE
Roth
Safe harbor
What are the characteristics of a traditional 401(k) plan?
AKA cash or deferred arrangement (CODA)
Qualified profit sharing or stock bonus plan under which participants have the option to contribute money on a pre-tax basis known as an elective deferral.
A 401(k) is an exception to the constructive receipt rule - the EE is not taxed on ER contributions until distribution
How much can an ER deduct for 401(k) contributions?
Up to 25% of EE payroll
What is an elective deferral?
Part of a 401(k) - the participants can elect to have a portion of their compensation put into the 401(k) on a pre-tax basis
When is a 401(k) plan appropriate?
When the owner cannot afford much outside of existing salary (401(k) is funded by the EE salary)
EEs are young and have time
ERs want to encourage their EEs to save
What is a negative election?
An automatic enrollment into an ERs company 401(k) as long as there is an option for the EE to opt-out
What are 401(k) safe harbor rules?
Safe Harbor avoids compliance to special nondiscrimination testing which apply to traditional 401(k). It allows for a high level of EE deferrals and is not subject to top-heavy provisions. To qualify, an ER must contribute to a plan where the EE is 100% vested immediately, one of the following two ways:
-3% ER contribution
-100% match on 3%, 50% up to 5% (total 4% match to 5% EE contribution)
What is the impact of the catch-up contributions on the maximum amount an EE or ER can contribute to a qualified plan?
There is no impact. The $6500 does not count against the contribution limit
