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Retirement Savings and Income Planning > Qualified Plan Rules and Options > Flashcards

Qualified Plan Rules and Options Flashcards

1
Q

What are the tax advantages for qualified plans - For employer

A
  • Employers can take a INCOME TAX DEDUCTION for the year contribtuions are made
    • These contribtuions are considered neccesary cost of doing business for purposes of deductibility
    • Max deduct is 25% of covered compensation during the year
  • Can also take a PAYROLL TAX DEDUCTION for EMPLOYER contributions
    • Employer and employee DO NOT have to pay FICA taxes on EMPLOYER CONTRIBUTIONS
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2
Q

Max Deduction for Employer for Contributions to Qualified Plan

A
  • Cannot be more than 25% of covered compensation during the year to employees covered by qualified plan
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3
Q

Qualified plan tax advantage - For employees

A
  • Do not have to pay income taxes until withdrawn (on both employer contributions and employee contributions)
  • Do not have to pay FICA taxes on EMPLOYER contributions
    • Altough, you still must pay FICA taxes on EMPLOYEE contributions
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4
Q

Qualified plans advantage - ERISA protection

A
  • Protected retirement assets in qualified plan from assignment or alienation, which includes bankruptcy or certain civil lawsuits
  • Funds are automatically protected by ERISA, until funds are distributed (no more protection)
  • If funds are rolled over from ERISA plan to IRA, protection carries over
  • If funds are commingled with other, NON ERISA rollovers/assets, NO PROTECTION
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5
Q

ERISA protection - Exclusions

A
  • ERISA does not protect against
    • QDROs
    • Federal Tax levies
    • Judgements for criminal acts
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6
Q

Main advantages of Qualified Plans

A
  • Taxes
  • ERISA protection
  • Distribution options
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7
Q

Disadvantages of Qualified Plans

A
  • Many rules and requirements
  • Costly for employers because of those rules and requirements
  • Usually limited investment choices for employees
  • Usually limited access to money for employees while still working
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8
Q

Qualified Plan Requirements include Rules About What? (HEAVILY TESTED)

A
  • Eligibility
  • Coverage and discrimination testing
  • Funding and contribution limits
  • Distribution
  • Vesting
  • Termination of plans
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9
Q

Qualified Plans - Eligibility

A
  • Each plan must have rules/requirements to state when employee is eligible to participate in the plan
    • Must be no stricter than standard requirement
      • Standard requirement is reaching age 21 AND ONE YEAR of service (1000 hours in 12-month period)
  • SECURE Act has extended to long-term, part-time employees to be able to make elective deferrals
    • Must have worked 500 hours for THREE CONSECUTIVE YEARS
    • Employer does NOT need to include them for nonelective deferrals or matching contributions
      • If they do, each year of 500 hours counts toward vesting
    • Employer does NOT include these workers in nondiscrimination testing
    • Starts on 1/1/2022 (so long-time, part-time employees probably can’t be eligible until 2024 at the earliest)
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10
Q

Qualified Plan - Eligiblity (Plan Entrance Date)

A
  • Must be offered AT LEAST every 6 months
  • Most have two every year
  • Once employee becomes eligible (service and age), employee can BEGIN partcipating in the plan at the NEXT PLAN entrance date
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11
Q

Qualified Plan - Eligiblity (Exception)

A
  • If employer elects TWO-YEAR service requirements
    • ALL CONTRIBUTIONS must be immediatley vested when they are eligibile to particpate in plan
  • THIS IS NOT AVAILABLE FOR 401K PLANS
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12
Q

When is an employee is considered a “covered employee”

A
  • When they receive any sort of MONETARY BENEFIT from the plan
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13
Q

Qualified Plan - Coverage and Disrimination Testing

A
  • Employer must consider ALL ELIGIBLE employees for participation in the plan
    • Not all eligible employees must be covered by the plan for plan to remain qualified
    • Eligible employees who are covered versus noncovered must be reasonable and objective
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14
Q

Qualified Plan - Coverage and Disrimination Testing (What employees are excluded)

A
  • Employees covered under collective bargaining agreement (union)
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15
Q

Who are HCEs?

A
  • MORE than 5% owner of company OR
  • Over a certain amount of income
  • BASED ON PRIOR YEAR (so if they were more than 5% owner or made certain amount of income in the prior plan’s year)
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16
Q

HCE Family Rules

A
  • Shares of stock owned by relatives will be counted toward particpant’s ownership total
    • Example
      • If John owned 10% of company and had his son work there as well as an employee
        • Son would also be considered HCE
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17
Q

Qualified Plan - Coverage and Discrimination Testing - HCE Exception

A
  • Employer can elect to ONLY consider top 20% of all paid employees as HCE (ranked by compensation)
  • Beneficial for company with a lot of HCE
  • Only helps reduce those that make a lot of money
  • Does NOT help reduce those who are more than 5% owner
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18
Q

What are the coverage tests?

A
  • Must meet ONE of the following coverage tests:
    • General safe harbor test
    • Ratio percentage test
    • Average benefits test
  • Defined benefit must ALSO pass the 50/40 test (so must pass two tests)
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19
Q

General Safe Harbor Test

A
  • Coverage test
  • Simplest to pass
  • Plan must BENEFIT 70% or more of eligible, NHC employees
    • Find out many eligible NHC employees there are
    • Then, divide how many benefit from plan / eligible NHC employees
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20
Q

Ratio Percentage Test

A
  • Coverage test
  • % of covered NHC employees / % of covered HCE
    • Must be equal to or greater than 70%
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21
Q

Average Benefits Test

A
  • Hardest coverage test
  • Must meet TWO tests:
    • Average benefits percentage test
    • Nondiscrimnatory classification test
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22
Q

Average Benefits Test - (Average Benefits percentage test)

A
  • Average benefit percentage of NHC employees / Average benefit percentage of HCE => 70%
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23
Q

Average Benefits Test - (Nondiscriminatory classification test)

A
  • Must meet either:
    • Safe harbor test OR
    • Facts and circumstances test
  • Safe harbor test
    • Plan’s ratio percentage is => employer’s safe harbor percentage
  • Facts and circumstances test
    • Commissioner finds that the classificaiton is nondiscrimatory based on ALL facts and circumstances
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24
Q

50-40 Test

A
  • Only for DEFINED BENEFIT PLANS (must also meet one of the other three tests)
  • Plan must benefit the LESSER OF:
    • 50 eligible employees OR
    • 40% of all eligible employees on each day of the plan year
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25
Q

What additional nondiscrimination tests do CODA plans need to pass?

A
  • The ADP test - actual deferral percentage
  • The ACP test - actual contribution percentage
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26
Q

ADP

A
  • Actual deferred percentage
  • Purpose is to ensure that NHC employees are not being discriminated gainst by comparing DEFFERAL amounts of HCE to NHC employees
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27
Q

ADP Test - Allowed Differences

A

ADP for NHC employees vs ADP allowed for HCE

  • 0-2% || 2 x ADP for NHC
  • 2-8% || 2% + ADP for NHC
  • 8% + || 1.25 x ADP for NHC
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28
Q

Two methods for ADP testing calculation

A
  1. Prior-year method
    • Calculcates max deferral for HCE based on the NHC employees’ ADP from the PRIOR year
  2. Current-year method
    • Calculcates max deferral for HCE based on NHC employees’ ADP from CURRENT year
      • Generally provides greater flexibility for plan sponsor!
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29
Q

How to calculate ADP

A
  • Determine average of each group (HCE and NHC) by averaging EACH employee’s ADP
  • Then use table as guide
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30
Q

ACP Test

A
  • Operates off contribution percentage for HCE and NHC employees
  • Contribution includes:
    • Employee after-tax AND
    • Employer-matching contributions
  • Calculated same as ADP
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31
Q

What corrective measures can be implemented for those who fail ADP and ACP?

A
  • Corrective distribution
  • Qualified nonelective contribution (QNEC)
  • Qualified matching contribtion (QMC)
  • Recharacterization
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32
Q

Which corrective measures are the LEAST costly?

A
  • Recharachterization and corrective distribution
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33
Q

Corrective Distribution

A
  • Distribute part of the deferred funds from the plan to the HCE
    • Which will reduce HCE ADP
  • Must be completed within 2.5 months after end of plan year or 10% penalty will be incurred
  • Any earnings on those contributions that were distributed back to the HCE must also be returned to HCE
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34
Q

QNEC

A
  • Employer will make a QNEC to all NHC employees to increase NHC ADP
  • Even though coming from employer, are counted as employee ELECTIVE deferrals (even though they are named nonelective deferreals)
  • Always 100% vested for these contributions
35
Q

QMC

A
  • Made to all employees who have ALREADY elected to defer or participate in the plan year
  • Matching contribution is treated as an addtional deferral by the employee, which increases their deferral percentage for NHC
  • Immediately vested contribution
36
Q

Recharacterization

A
  • Recharacterize excess deferrals, which are pretax
    • To after-tax contributions
  • Must be completed within 2.5 months of end of plan year, otherwise 10% penalty
  • Helps ADP test but NOT ACP test (because of the after-tax contributions now counting towards that)
37
Q

Safe Harbor 401(k) Plans

A
  • Employers can AVOID the ADP/ACP tests if they make this safe harbor election (for 401k)
  • Contributions must me 100% immediately vested
  • Allowed contributions are either:
    • 3% nonelective contribution OR
    • A matching contribution
      • If matching:
        • Employer must match 100% of first 3% elective deferrals AND
        • At least 50% of deferrals greather than 3 but less than 5%
  • Max employer contribution can be 4% if you make elective deferrals of 5% or more
38
Q

Employer amending their plan to be safe harbor plan

A
  • If employer implements safe harbor 401k on:
    • Matching rates:
      • plan must be amended 60 days prior to beginning of year
    • Nonelective contribution
      • plan can be amended as late as 30 days prior to end of plan year
    • 4% nonelective employer contribution
      • can be amended as late as last day of year
39
Q

Vesting - Employee’s contributions and earnings

A
  • Both are immediately vested (earnings also on employee contributions)
40
Q

Types of vesting schedules

A
  • Graduated vesting schedule
    • Each year, addtitional percentage is allowed
  • Cliff-vesting schedule
    • Once they reach years of service required, then they are vested
41
Q

Defined Contribution Plan Vesting Schedules

A
  • Graduated
    • 2-6 year (0,20,40,60,80,100%)
  • Cliff
    • 3-year (0,0,100%)
42
Q

Defined Benefit Plan Vesting Schedules

A
  • NON TOP HEAVY
    • Graduated
      • 3-7 year (0,0,20, etc)
    • Cliff
      • 5-year
  • TOP HEAVY
    • Same as defined contribution
43
Q

When does years of service begin for vesting purposes?

A
  • When you begin employment, not when you are eligible
  • Year 1 is considered 12 consective months with at least 1000 hours worked
  • Long-term, part-time can also receive years of service for vesting before 2021 (at least 500 hours worked)
44
Q

Employer exceptions to counting years of service toward vesting

A
  • Years of service acquired before turning age 18
  • Years of service acquired before employer sponsored the qualified plan
  • Years of service attained during the years when employee did not contribute to an employee-contriburoty plan
45
Q

When can vesting be immediately available (for employer contributions)

A
  • If employer elects two-year service requirement
46
Q

Key Employee

A
  • Employer that is greater than 5% owner
  • Officer with compensation in excess of what’s on exam table
  • Employee that is greater than 1% owner with compensation in excess of 150k
47
Q

Key Employer - What is an officer?

A
  • Someone who has a source of authority and is usually an admin executive
  • No more than 50 employees must be treated as officers
    • If there are more than 50 officers in a company, only the top 50, ranked by compensation, will be considered officers for purposes of being a key employee
48
Q

HCE vs Key Employee

A
  • Remember that HCE can be key employee and vice versa.. but the definitions are different
49
Q

Top-Heavy Testing

A
  • For defined contribution plans
    • If total balance of key employees exceeds 60% of the total account balance of all employees, it’s top heavy
  • For defined benefit plans
    • If PV of benefits for key employees exceed 60% of PV of benefits for all employees, it is top heavy
50
Q

What happens if a plan is top-heavy?

A
  • Must use top-heavy vesting schedules (only for defined benefit)
  • Must provide a certain level of funding to nonkey employees
51
Q

Top-Heavy Funding

A
  • Defined contribution
    • Must provide employees a contribution equal to at least 3% of employee’s compensation
      • UNLESS the largest contribution made on behalf of all key employees is LESS than 3% of compensation, then the 3% requirement is not required
  • Defined benefit
    • Uses a special unit credit formula
    • 2% x Years of service x average annual compensation (based on testing period for the avg compensation)
52
Q

Covered Compensation Limit

A
  • The max amount of compensation that can be considered in funding formulas
53
Q

Defined benefit plans - Max annual retirement benefit

A
  • Lesser of:
    • Defined Annual Limit benefit (in tables)
    • 100% of the employee’s THREE HIGHEST CONSECUTIVE years of compensation (averaged)
      • Just remmeber the covered compensation limit
  • Remember:
    • Contributions are NOT limited to defined benefit plans (because they have to make sure there is adequate funding)
54
Q

Defined contribution plans - Max contribution limits

A
  • Lesser of
    • 100% of employee’s annual compensation
    • Max Annual defined contribution limit (in tables)
      • Age 50 and older and in CODA plan (401k) can go above this limit for catch-up ELECTIVE deferrals
55
Q

Defined Contribution Plan - What does max contribution consists of

A
  • Employer contributions to plan
  • Employee contributions to plan
  • Forfeitures from terminated, nonvested employees
56
Q

Employer Contributions Deduction

A
  • Only for defined contribution plans - up to 25% of employee’s compensation (salary)
  • If employer maintains multiple qulaified defind contriution plans
    • Limit is COMBINED for all plans (annual limit applies per employee, not per plan)
57
Q

What is a controlled group?

A
  • Group of businesses (two or more) that are under COMMON CONTROL
  • Rules were put into place to prevent an owner from creating separate businesses to allow for increased retirement contribution or to avoid making contributoins for certain employees
58
Q

Controlled Groups - The different relationships

A
  • Parent-subsidiary
  • Brother-sister
  • Combined Group
59
Q

Parent-Subsidiary and Requirements to be considred controlled group

A
  • This occurs when multiple corporations are connect through a common PARENT corporation
  • Following requirements must be met to be considred a controlled group:
    • 80% of the stock of each corporation must be owned by at least one other coporation in the group
    • The parent owns 80% of at least one other corporation
60
Q

Brother-Sister and how it is controlled group?

A
  • Consists of at least two corporations
  • Between those corporaitons, FIVE OR FEWER owners have direct or indirect controlling interest of each group and have effective control
    • Controlling interest
      • Means the group of five or fewer owners own 80% or more of the stock in each corporaiton
    • Effective control
      • More than 50% of the stock of each corporation, only to the extent such stock ownership is identical with respect to such corporation
        • Just make sure to look at each owner’s ownership percentage in each corporation (and pick the lower number between the two)
          • Do the same with all other members and see if it adds over 50%
61
Q

Combind Group

A
  • Consists of three or more organizations and organized in the following way:
    • Each organization is a member of a parent-subsidiary OR brother-sister group AND
    • At least one corporation is the common parent of a parent-subsidiary and is also member of a brother-sister group
62
Q

What are the noraml distributions option for CODA plans?

A
  • Retirement, death, separation from service and attainment of age 55
  • Terminatin of plan without the establishment of another plan
  • Acquisitions of company/assets
  • Attainment of age 59.5
  • Penalty-free up to 5k per parent for birth of child/adoption (must be withdrawed within one year of the event - SECURE ACT
  • 2020 ONLY - COVID - up to 100k penalty free and can pay tax back over three year period
  • Certain hardships
63
Q

Hardship Distributions - Max amount allowed

A
  • Max distributable amount is equal to employee’s ELECTIVE deferral contribution reduced by any previous distributions of elective deferrals
64
Q

Hardship withdrawals - Penaly and tax?

A
  • Subjec to ordinary income tax
  • Could be subject to early withdrawal penatly
65
Q

Plan Loans from Qualified Plans

A
  • Not REQUIRED for qualified plans, but do allow it
  • Does NOT get 10% penalty
  • Must be allowed to all participants on equal basis
  • Plan loan:
    • Must be limited in amount
    • Must be paid back within reasonable amount of time (usually 5 years)
    • Must have reasonable interest rate
  • If plan loan is used to purcahse perosnal residence, then loan can be as long as 30 years
66
Q

Qualified plan loan amounts

A
  • Permit the LESSER:
    • 1/2 of vested accrued benefit OR
    • $50,000
  • If vested benefit is LESS than or EQUAL to $20,000, then:
    • Lesser of:
      • $10,000 OR
      • Accrued benefit
  • Max available loan amount is REDUCED by any outstanding loans
    • If a loan was made within 12 months of another loan:
      • Max available loan amount will be REDUCED by the MAX BALANCE within the last 12 months (meaning that even if you paid any back during those 12 months, it won’t count for max available loan purposes)
67
Q

Repayment of Plan Loans

A
  • Failure to repay loans could result in the loan being treated as a DISTRIBUTION
68
Q

Repayment of Loans - Deemed Distribution

A
  • This could happen when an employee is terminated and they do not pay back their loan or their loan goes into default
  • The employer could then distribute the proceeds in the plan to cover the oustanding loan, which could result in early withdrawal penalties (if not a qualified distribution such as separation form service at age 55, death, etc) and ordinary income taxes.
  • The employee has the option to ROLLOVER the deemed distribution into an IRA (at or after termination) so that they can AVOID income taxes and penalties
    • Deadline to do this is the tax return deadline in the year that the deemed distribution took place
    • Amount that must rolled over the OUTSTANDING LOAN amount at the time of termination.
69
Q

Steps into establishing the qualified plan

A
  1. Adopt the plan
  2. Notify employees
  3. Choose investments for the plan
70
Q

Adopting the qualified plan

A
  • Plan must be adopted by the tax return deadline for that year (inlcuding extensions) in order for tax deductions to be taken for that year
    • 401k CODA plans must be established BEFORE the end of the plan year so that employees have time to contribute
  • Plans must follow either:
    • Master plan - already approved by IRS (standard form) and simple
    • Individually designed plans - must be approved by IRS and usually for specific needs of the company
  • IRS determination letter is used to ensure the plan is qualified:
    • Can be secured before or after plan is adopted
71
Q

What employees should be notified about the qualified plan?

A
  • ALL (both eligible and ineligible employees)
72
Q

Notifying employees - What do they provide

A
  • A summary of details of the plan to participants, employees and bene’s currently receving benefits who request the info
  • Must provide notices of any amendments or changes to plan document
  • Summary annual report must also be provided every year to participants
  • IRS must receive evidence of notifying all employees about the plan BEFORE issuing determination letter
73
Q

Who can choose investments for plan assets in qualified plans?

A
  • Can be managed by:
    • the participants
    • the plan sponsor OR
    • an outside asset management firm
74
Q

Within the retirement plan, participants must have what in regards to the investments available?

A
  • Must have at LEAST 3 funds to invest in
  • Funds must be:
    • Diversified
    • Have different risk and return characteristics
    • Allow for reduction in risk through diversificiaotn with the other investments
75
Q

Employers operating the plan - fiduciary

A
  • Must always act in the best interests of the participants
76
Q

Employers are required to file what form for qualified retirement plans and what is the failiure-to-file penalty?

A
  • Form 5500 must be filed ANNUALLY
  • Penalty for not filing is:
    • $250/day w/ max penalty of $150,000
77
Q

What causes a prohibited transaction?

A
  • A transaction that occurs between a disqualifying person and the plan
78
Q

Who is a disqualified person?

A
  • A disqualified person is ANY of the following:
    • A fiduciary of the plan
    • A person providing services to the plan
    • An employer whose employees are covered by the plan
    • An employee organization whose members are covered by the plan
    • Any direct or indirect towner of 50% or more of any of the following:
      • Combined voting power of all classes of stock related to the corporation entitled to vote
      • Capital interest or profits interest of a partnership that is an employer or employee organization described above
      • The beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described above
    • A member of the family of ANY individual described in the previous bullet points
79
Q

Transactions that are prohibited if conducted with disqualiying person

A
  • Transfer of plan income or assets to/for the use of a disqualified person
  • Self-dealing by a fiduciary
  • Selling, exchanging, leasing, buying, and lending between a disqualified person and the plan
  • Prohibited transactions are subject to a 15% EXCISE TAX on the AMOUNT INVOLVED
    • If transaction occurred within 14 days of discovering the prohibited transaction, NO EXCISE TAX IS ASSESED
  • Fiduciaries who are compensated for investment advice to particpiants in the plan IS NOT A PROHIBITED TRANS.
80
Q

Who has the right to terminate/change qualified plans and what are some reasons?

A
  • The employer has the right to change/terminate plans
  • Some reasons include:
    • Laws that change that may make the current plan less advantageous than other ones
    • Employer could no longer pay and maintain the plan
    • Employer realizes that plan is no longer meeting needs of employees or company
  • CANNOT JUST ABANDON PLAN within a few years without sufficient cause:
    • Could be seen as evidence that plan was not set up to benefit employees
81
Q

What happens to employees’ accounts when plan is terminated?

A
  • Becomes fully vested at time of termination
82
Q

Defined benefit plan termination

A
  • Much harder than defined contribution plans because of PBGC
  • Three types of terminations:
    • Standard - voluntary and employer has sufficient assets to pay beenfits at time of final distribution
    • Distress - volutnary and employer us unable to continue with plan financially
    • Involuntary - initiated by PBGC because employer is unable to pay benefits (lessens PBGC losses)
    • Freeze - means they will stop contributing to plan and no more accrual of benefits, but previous accruals will remain without terminating the plan
83
Q

Defined contribution plan termination

A
  • Employer must pass a corporate resolution to dissolve the plan
  • Then final contributions and assets will be distributed

Retirement Savings and Income Planning (11 decks)

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