Retirement: 2 Planning for Retirement, SS, and Defined Benefit Plans Flashcards
1
Q
Retirement: 2-1 Defined Benefit Pensions
The GRF Corporation’s traditional defined benefit plan provides a benefit that entitles Evelyn James to an annual pension of 100% of her final average pay at age 65. Her salary is $225,000; a 100% benefit would amount to $225,000. However, the plan may fund a benefit for her of only $_____ in 2016
a. $100,000
b. $210,000
c. $225,000
d. $450,000
2-1
A
b. $210,000
However, the plan may fund a benefit for her of only $210,000 in 2016—the lesser of $210,000 or $225,000.
As a rule, a participant’s annual benefit cannot exceed the lesser of $210,000 (as indexed in 2016) or 100% of annual compensation. This is the IRC Section 415(b) limit.
2
Q
Retirement: 2-1 Defined Benefit Pensions
Jonathan works for Mixed Nuts Corporation and his current salary is $35,000. The maximum annual pension benefit for him allowed under Section 415(b) would be:
a. $35,000
b. $70,000
c. $100,000
d. $210,000
2-1
A
a. $35,000
The lesser of $210,000 or 100% of compensation. In this case, 100% of compensation is the lower number.
As a rule, a participant’s annual benefit cannot exceed the lesser of $210,000 (as indexed in 2016) or 100% of annual compensation. This is the IRC Section 415(b) limit.
3
Q
Retirement: 2-1 Defined Benefit Pensions
The plan provides security for employees in the form of a specified benefit and also is backed by the:
a. The Federal Government
b. FDIC
c. ERISA
d. Pension Benefit Guaranty Corporation (PBGC)
2-1
A
d. Pension Benefit Guaranty Corporation (PBGC)
4
Q
Retirement: 2-1 Defined Benefit Pensions
Generally the “crossover” range, in which a traditional defined benefit plan can become more attractive than a defined contribution plan is between ages:
a. 35 to 40
b. 45 to 50
c. 45 to 55
d. 50 to 60
2-1
A
b. 45 to 50
5
Q
Retirement: 2-1 Defined Benefit Pensions
The retirement benefits provided by a defined benefit plan are governed by three determinants. Which is NOT one of them?
a. the benefit formula
b. the participant’s compensation
c. the prevailing interest rates at retirement
d. the participant’s years of service or participation
2-1
A
c. the prevailing interest rates at retirement
6
Q
Retirement: 2-1 Defined Benefit Pensions
In virtually all plans, normal retirement age will also include a service factor. A common example is:
a. the later of age 65 or completion of five years of service
b. the later of age 62 or completion of five years of service
c. the later of age 60 or completion of five years of service
d. the later of age 65 or completion of ten years of service
2-1
A
a. the later of age 65 or completion of five years of service
7
Q
Retirement: 2-1 Defined Benefit Pensions
Compensation is the individual’s total earnings, as defined in the plan document. Such definition must be nondiscriminatory, which means it must satisfy sections _____ of the Internal Revenue Code.
a. 404(s) and 455(c)(3)
b. 444(s) and 415(c)(3)
c. 414(s) and 455(c)(3)
d. 414(s) and 415(c)(3)
2-1
A
d. 414(s) and 415(c)(3)
8
Q
Retirement: 2-1 Defined Benefit Pensions
The definition of total earnings will satisfy safe harbor provisions if it includes all compensation within the meaning of _____ and excludes all other compensation. For our purposes, wages, salaries, fees for service, and any item included in income meet this definition requirement.
a. Section 415
b. Section 315(c)(3)
c. Section 415(c)(3)
d. Section 515(c)(3)
2-1
A
c. Section 415(c)(3)
9
Q
Retirement: 2-1 Defined Benefit Pensions
Jane works for ABC Corporation and is a participant in their defined benefit plan. The plan’s definition of compensation excludes bonuses. She earns $50,000 per year, and will receive a Christmas bonus of $3,000. In calculating her retirement benefit ABC will take into account:
a. her $50,000 of wages and her $3,000 bonus.
b. her $50,000 of wages, but not her $3,000 bonus.
2-1
A
b. her $50,000 of wages, but not her $3,000 bonus.
10
Q
Retirement: 2-1 Defined Benefit Pensions
Compensation, or “pay,” will be defined in the plan document as either one of two ways: _____ is the highest three or five years of compensation prior to a participant’s retirement
a. final average pay
b. career average pay.
2-1
A
a. final average pay
11
Q
Retirement: 2-1 Defined Benefit Pensions
Compensation, or “pay,” will be defined in the plan document as either one of two ways: _____ is the average compensation for all years of service
a. final average pay
b. career average pay.
2-1
A
b. career average pay.
12
Q
Retirement: 2-1 Defined Benefit Pensions
Compensation, or “pay,” will be defined in the plan document as either final average pay, or career average pay. For most employees, this option will be a more favorable provision:
a. final average pay
b. career average pay.
2-1
A
a. final average pay
13
Q
Retirement: 2-1 Defined Benefit Pensions
The definition of compensation must also meet the requirements of IRC Section 401(a)(17), which imposes an annual limit on the amount of compensation that
can be considered in calculating a qualified plan contribution or benefit. This limit is _____ in 2016.
a. $118,500
b. $210,000
c. $265,000
2-1
A
c. $265,000
14
Q
Retirement: 2-1 Defined Benefit Pensions
John Salzur has received $305,000 per year in W-2 compensation for the past four years and participates in his employer’s defined benefit plan. The plan provides a flat percentage benefit of 36.25% of compensation, defined as the average final three years of compensation. Because John’s salary has been above the compensation limit for the past three years, his benefit under the defined benefit plan will be 36.25% of the compensation limit. In 2016, his employer can only fund for a benefit of:
a. $210,000
b. $110,562.50
c. $265,000
d. $96,062.50
2-1
A
d. $96,062.50
In 2016, his employer can only fund for a benefit of $96,062.50 per year at retirement, which is 36.25% of $265,000. His benefit cannot be 36.25% of his full amount of $305,000 of compensation; it is calculated only on amounts up to $265,000.
15
Q
Retirement: 2-1 Defined Benefit Pensions
A defined benefit plan is required to define the age at which full benefits will commence. This is known as:
a. Normal retirement age
b. Full retirement age
2-1
A
a. Normal retirement age
Normal retirement age is used as the target age in plan funding calculations. It has little to do with when an employee will actually retire or when benefit accruals under the plan will cease. Benefit accruals will not cease (assuming the employee has not attained the maximum benefit provided by the plan) until the employee retires. Since an employee may continue to work beyond the normal retirement age, the employee may continue to earn accruals under the plan.
16
Q
Retirement: 2-1 Defined Benefit Pensions
Early retirement. A typical requirement for plans that do allow early retirement is that employees have at least __ years of service or participation in the plan, and be at least age 55 to be eligible for early retirement.
a. 5
b. 10
c. 15
d. 20
2-1
A
b. 10
17
Q
Retirement: 2-1 Defined Benefit Pensions
Late retirement. If a worker retires after age 65 or delays taking retirement benefits past age 65, then the IRC Section 415(b)(2)(A) dollar limit on benefits ($210,000 for 2016) _____ be actuarially adjusted upward.
a. must
b. cannot
c. may
2-1
A
a. must
This is similar to Social Security, in which benefits are reduced if a worker starts taking those benefits before full retirement age (FRA); but if the worker waits until after FRA to start taking benefits, then his or her benefit is increased.
Example. Bob, age 55, has been a teacher for 30 years, and the defined benefit plan for his school district accrues a benefit of 2% of compensation for every year of service up to a maximum of 30 years. This means that Bob has reached a maximum benefit of 60% of compensation, which he could start taking now if he were to retire. If Bob continues to work for another year he will still be receiving 60% of compensation as his annual retirement benefit, not 62%. However, assuming Bob gets a raise each year, it would now be 60% of a slightly larger amount, since the plan takes the highest three years of compensation when calculating the benefit.
18
Q
Retirement: 2-1 Defined Benefit Pensions
Benefit Formulas. Generally, there are two types of formulas used. _____ considers years of service.
a. unit benefit or unit credit formula
b. flat benefit formula
2-1
A
a. unit benefit or unit credit formula
19
Q
Retirement: 2-1 Defined Benefit Pensions
Benefit Formulas. Generally, there are two types of formulas used. _____ provides a benefit regardless of length of service.
a. unit benefit or unit credit formula
b. flat benefit formula
2-1
A
b. flat benefit formula
20
Q
Retirement: 2-1 Defined Benefit Pensions
Example. Roberta will retire at the end of the year. The defined benefit plan used by her employer bases the annual benefit on a percentage of average annual pay
during the three years prior to retirement. Roberta’s pay during the final three years of her employment was $48,000, $49,000, and $50,000, respectively. According to the plan, she will receive an annual benefit equal to 40% of her final average annual
pay, or:
a. $18,600
b. $19,600
c. $20,600
2-1
A
b. $19,600
The average of these—her final average annual pay—is $49,000.
$48,000 $49,000 $50,000 = $147,000 / 3 = $49,000 * 40% = $19,600
21
Q
Retirement: 2-1 Defined Benefit Pensions
Because a flat percentage formula fails to consider an employee’s length of service, it fails to meet the needs of companies that insist their plans reflect a sense of equity or
a. fairness
b. unearned entitlement
c. earned entitlement
2-1
A
c. “earned entitlement.”
22
Q
Retirement: 2-1 Defined Benefit Pensions
Example. As a retiring employee of Alpha Omega Limited, Fred is slated to receive 3% of his final five-year average salary for every year he was employed by Alpha Omega. Since Fred’s average salary during those last five years was $70,000 and he put in 23 years of service, his annual retirement benefit is
calculated as:
a. $47,300
b. $48,300
c. $49,300
2-1
A
b. $48,300
$70,000
* 3%
* 23
= $48,300
23
Q
Retirement: 2-1 Defined Benefit Pensions
If the plan participant is married, the plan must provide a _____, which continues to pay benefits as long as either the retiree or the spouse continues to live. In effect, it is a life annuity that considers two lives. In most cases, the payment to the survivor is 50% of the joint annuity,
a. qualified joint and survivor annuity (QJSA)
b. qualified optional survivor annuity (QOSA)
c. qualified preretirement annuity (QPSA)
2-1
A
a. qualified joint and survivor annuity (QJSA),
24
Q
Retirement: 2-1 Defined Benefit Pensions
If the plan participant is married, the plan must provide a life annuity that considers two lives. In most cases, the payment to the survivor is 50% of the joint annuity, but a survivor annuity of 75% must also be offered (called a _____) as required by the Pension Protection Act.
a. qualified joint and survivor annuity (QJSA)
b. qualified optional survivor annuity (QOSA)
c. qualified preretirement annuity (QPSA)
2-1
A
b. qualified optional survivor annuity (QOSA)
25
Retirement: 2-1 Defined Benefit Pensions
If the plan participant is married, the plan must provide a _____, which provides benefits to the surviving spouse in case the participant dies before the annuity starting date.
a. qualified joint and survivor annuity (QJSA)
b. qualified optional survivor annuity (QOSA)
c. qualified preretirement annuity (QPSA)
2-1
c. qualified preretirement annuity (QPSA).
26
Retirement: 2-1 Defined Benefit Pensions
In addition to offering annuities, defined benefit plans _____ required, to offer a lump-sum alternative.
a. are
b. are not
2-1
b. are not
27
Retirement: 2-1 Defined Benefit Pensions
If a participant leaves the company with less than _____ in vested benefits, a plan usually will pay out the benefit in a single lump sum. The cost of keeping these low balance participants on the rolls is just too high relative to the value of their benefits.
a. $1,000
b. $2,000
c. $5,000
2-1
c. $5,000
28
Retirement: 2-1 Defined Benefit Pensions
Another option available is one for a fixed period. This provides regular monthly payments over a specified period. Even if the recipient (and spouse) happens to die during the specified period this option ensures payments to a named beneficiary.
True or False
2-1
True
29
Retirement: 2-1 Defined Benefit Pensions
The _____ formula relates the retirement benefit to each participant’s level of compensation. For example, the plan may specify that it will pay an annual retirement benefit equal to 35% of the participant’s annual final compensation (or the average compensation for the final three years).
a. flat amount formula
b. flat percentage formula
c. unit benefit formula
2-1
b. flat percentage formula
30
Retirement: 2-1 Defined Benefit Pensions
The _____ formula promises each plan participant an annual flat dollar amount for each year of service; for example, $100 for each year of service to the company.
a. flat amount formula
b. flat percentage formula
c. unit benefit formula
2-1
a. flat amount formula
31
Retirement: 2-1 Defined Benefit Pensions
Example. Let’s assume John Baker’s final average compensation is $120,000 and his employer of 30 years, Charmed Biscuit Company, offers a defined benefit plan with the following offset integrated benefit formula: 2.75% per year of service times a participant’s average annual compensation minus .75% per year of service times a participant’s final average compensation up to such person’s covered compensation level. Also, the plan document states that a participant’s final average compensation cannot exceed the amount of such person’s average annual compensation. Under these facts, John’s benefit is calculated as follows:
a. $99,000
b. $18,000
c. $81,000
2-1
c. $81,000
John’s gross benefit (before taking the offset into account) = 2.75% x 30 x $120,000 = $99,000; and
The offset against John’s gross benefit = 75% x 30 x $80,000 = $18,000;
Hence, John will receive an annual retirement benefit equal to $81,000 ($99,000– $18,000 = $81,000), which will be paid to him in the form of a monthly annuity.
Note: John receives the same benefit, $81,000, regardless of which permitted disparity method is used.
32
Retirement: 2-2 Defined Benefit Pensions
Typical ERISA eligibility for participation in a qualified plan is age ____
a. 18 and 1 year of service
b. 21 and 1 year of service
c. 21 and 5 year of service
2-2
b. 21 and 1 year of service
33
Retirement: 2-2 Defined Benefit Pensions
A top-heavy plan is a qualified retirement plan in which more than __% of plan benefits are attributed to key employees.
a. 20%
b. 40%
c. 60%
2-2
c. 60%
34
Retirement: 2-2 Defined Benefit Pensions
Qualified plan that provides a specified retirement benefit based on a flat or unit formula
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
35
Retirement: 2-2 Defined Benefit Pensions
Qualified defined benefit plan that provides specified employer contributions and a guaranteed
return
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
b. Cash Balance Plan
36
Retirement: 2-2 Defined Benefit Pensions
Favors older participants (nearer to retirement age)
The only plan that can enable owner to meet retirement objective
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
37
Retirement: 2-2 Defined Benefit Pensions
Favors younger participants
Allows company to amend defined benefit plan to simplify and reduce cost
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
b. Cash Balance Plan
38
Retirement: 2-2 Defined Benefit Pensions
Annual contributions required, therefore:
1. business must have stable (or increasing) cash flow, and
2. owner must be willing to commit to annual contributions
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
39
Retirement: 2-2 Defined Benefit Pensions
Contribution limit = amount necessary to fund benefit of up to the lesser of $210,000 (in 2016) or 100% of compensation averaged over the three years of highest compensation
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
40
Retirement: 2-2 Defined Benefit Pensions
Flat benefit formula = flat amount or flat percentage of pay
Unit benefit formula = flat amount per year of service, or percentage of pay per year of service
Maximum amount of includible compensation is $265,000 in 2016
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
41
Retirement: 2-2 Defined Benefit Pensions
Employer contributes a specified
percentage of pay and guarantees an investment return each year
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
b. Cash Balance Plan
42
Retirement: 2-2 Defined Benefit Pensions
Subject to minimum funding standard
Annual actuarial determination on funding standard account
PBGC can terminate plan if inadequately funding
Employer assumes investment risk
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
43
Retirement: 2-2 Defined Benefit Pensions
Earnings affect employer contributions
Forfeitures must be applied to reduce employer contribution
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
44
Retirement: 2-2 Defined Benefit Pensions
Allocation method of benefits
Per plan formula—generally contributions will be higher for participants who are closer to retirement age due to years of service and higher compensation
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
45
Retirement: 2-2 Defined Benefit Pensions
Benefit determination
Per plan formula—contributions equal to a fixed percentage of compensation are credited to a participant’s account; the plan uses actuarial assumptions to convert the hypothetical account into annuity payments (or a lump-sum payment) at
retirement
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
b. Cash Balance Plan
46
Retirement: 2-2 Defined Benefit Pensions
Benefit determination
Per plan formula (employer assumes the risk)
Factors affecting contributions: investment returns, forfeitures, participants’ salary levels)
Factors affecting contributions: salary, participants’ proximity to retirement age
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
47
Retirement: 2-2 Defined Benefit Pensions
factors affecting contributions: salary
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
b. Cash Balance Plan
48
Retirement: 2-2 Defined Benefit Pensions
Vesting: may use five-year cliff or seven-year graded (unless top heavy, then three-year cliff or six-year graded)
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
a. Defined Benefit Pension Plan
49
Retirement: 2-2 Defined Benefit Pensions
Vesting: participants must be 100% vested after completing three years of service—e.g., three year cliff
a. Defined Benefit Pension Plan
b. Cash Balance Plan
2-2
b. Cash Balance Plan
50
Retirement: 2-3 Defined Benefit Pensions
If the plan benefits 70% or more of the non-excludible, non-highly compensated employees (NHCEs) then it automatically passes the test and the next two tests are not required
a. Safe harbor coverage test
b. Ratio percentage test
c. Average benefits test.
2-3
a. Safe harbor coverage test
51
Retirement: 2-3 Defined Benefit Pensions
The percentage of non-excludible, non-highly compensated employees (NHCEs) who benefit by participating in the retirement plan must equal at least 70% of the HCEs who benefit by participating in the plan (so if 90% of the HCE employees are participating, then at least 63% of the NHCEs must be participating: .70 × .90)
a. Safe harbor coverage test
b. Ratio percentage test
c. Average benefits test.
2-3
b. Ratio percentage test
52
Retirement: 2-3 Defined Benefit Pensions
There are two components to this test.
1. The plan must benefit a nondiscriminatory classification of employees.
2. The plan must provide an average benefit percentage for NHCEs that is
at least 70% of the average benefit percentage of the HCEs.
a. Safe harbor coverage test
b. Ratio percentage test
c. Average benefits test.
2-3
c. Average benefits test.
53
Retirement: 2-3 Defined Benefit Pensions
Defined benefit plans (both the traditional defined benefit pension plan and the cash balance plan) are required to meet certain minimum participation requirements. On each day of the plan year, a defined benefit plan’s prior and current benefit structure must provide “meaningful benefits” to at least the lesser of:
__ employees, or
the greater of:
40% of all the company’s employees, or
two employees (or one employee if there is only one employee).
a. 30
b. 40
c. 50
2-3
c. 50
54
Retirement: 2-3 Defined Benefit Pensions
Examples of the 50/40 Test
The Goodnight Mattress Company has 500 employees and a defined benefit plan. Only 64 employees participate in the plan and have meaningful accrued benefits out of 150 who are ERISA eligible. Does it pass the 50/40 test?
a. Yes
b. No
2-3
a. Yes
40% of 150 = 60, and the lesser of 50 or 60 is 50. Therefore it passes the 50/40 test.
55
Retirement: 2-3 Defined Benefit Pensions
Willard Smith and Co. is a broker-dealer with 120 employees and a defined benefit plan. Only 48 employees participate in the plan and have meaningful accrued benefits, but there are 103 ERISA eligible employees. Does it pass the 50/40 test?
a. Yes
b. No
2-3
a. Yes
40% of 103 = 41 employees; 41 is less than 50, therefore, 41 is the operable requirement. It passes the 50/40 test since 48 participate.
56
Retirement: 2-3 Defined Benefit Pensions
Baby Strollers Inc. is Ralph Jones’ stroller manufacturing company. He employs 10 employees who have been with him over 10 years and are all over age 25. He offers a defined benefit plan and three employees participate and have meaningful accrued benefits. Do they pass the 50/40 test?
a. Yes
b. No
2-3
b. No
The corporation has only 10 employees, so we apply the 40% test to see if this pension plan meets the 50/40 test. Under the 40% test, at least four employees must participate and have meaningful accrued benefits (40% × 10 = 4 employees), and 4 is greater than 2, the minimum threshold for this test). The plan fails the 50/40 test
because only three employees are in the plan.
57
Retirement: 2-3 Defined Benefit Pensions
Definition of a Highly Compensated Employee: Current law defines an HCE as any employee who
was a more-than-_% owner at any time during the current or preceding year,
or
received compensation from the company during the previous year in excess of the compensation threshold for that year. The compensation threshold for a particular year is based on the compensation threshold in effect during the lookback year. In 2016 the compensation threshold in effect during 2015 (the lookback year for 2016) was $120,000. Therefore, for 2016, we look back to see which persons were HCEs (or potential HCEs) in 2015 based on their earnings, which would be those employees earning in excess of $120,000, the indexed amount for that year
a. 2%
b. 5%
c. 10%
2-3
b. 5%
58
Retirement: 2-4 Defined Benefit Pensions
The average of the employee’s annual compensation (but not to exceed the taxable wage base in effect at the beginning of each year) for the three-consecutive-year period ending in the plan year or the employee’s period of employment if shorter.
a. Average annual compensation
b. Covered compensation limit.
c. Integration level
d. Base contribution percentage
c. Permitted disparity
e. Excess benefit/contribution percentage
2-4
a. Average annual compensation
59
Retirement: 2-4 Defined Benefit Pensions
The average of the Social Security wage bases in effect for each calendar year during the 35-year period ending with the year in which the participant attains Social Security full retirement age. This amount was approximately $72,600 for 2015.
a. Average annual compensation
b. Covered compensation limit.
c. Integration level
d. Base contribution percentage
c. Permitted disparity
e. Excess benefit/contribution percentage
2-4
b. Covered compensation limit.
60
Retirement: 2-4 Defined Benefit Pensions
The amount used as the “cutoff” in determining the compensation on which the higher benefit/contribution rate will apply.
Integrated defined benefit plans typically use the “covered compensation limit” as their integration level.
Integrated defined contribution plans typically use the current Social Security wage base as their integration level.
a. Average annual compensation
b. Covered compensation limit.
c. Integration level
d. Base contribution percentage
c. Permitted disparity
e. Excess benefit/contribution percentage
2-4
c. Integration level
61
Retirement: 2-4 Defined Benefit Pensions
Plan benefit/contribution percentage paid on compensation below the integration level.
a. Average annual compensation
b. Covered compensation limit.
c. Integration level
d. Base contribution percentage
c. Permitted disparity
e. Excess benefit/contribution percentage
2-4
d. Base contribution percentage
62
Retirement: 2-4 Defined Benefit Pensions
These rules limit the degree to which the plan can discriminate in favor of higher-paid employees. The permitted disparity in an integrated plan is the difference between the excess benefit/contribution percentage and the base benefit/contribution percentage.
a. Average annual compensation
b. Covered compensation limit.
c. Integration level
d. Base contribution percentage
c. Permitted disparity
e. Excess benefit/contribution percentage
2-4
c. Permitted disparity
63
Retirement: 2-4 Defined Benefit Pensions
The base benefit/contribution percentage plus the permitted disparity gives you the excess benefit/contribution percentage.
a. Average annual compensation
b. Covered compensation limit.
c. Integration level
d. Base contribution percentage
c. Permitted disparity
e. Excess benefit/contribution percentage
2-4
e. Excess benefit/contribution percentage
64
Retirement: 2-4 Defined Benefit Pensions
If a defined benefit plan uses the excess method, the permitted disparity (amount above the base benefit percentage) that is allocated to the retirement plan may not exceed the base benefit percentage by more than the lesser of the following two amounts:
the base benefit percentage
or
__% of each year of service (not to exceed 35 years) taken into account for
benefit accrual purposes.
a. 0.55%
b. 0.65%
c. 0.75%
2-4
c. 0.75%
65
Retirement: 2-4 Defined Benefit Pensions
Excess Method: This increased benefit is limited to the lesser of the base benefit percentage (the benefit percentage paid on earnings below the covered
compensation limit per year of service) or .75% per year of service up to a maximum of 35 years. If you do the math you will see that the maximum permitted disparity is ___%. This is found by multiplying .75% x 35 years. For participants with fewer than 35 years in the plan, their maximum permitted disparity will be reduced on a pro rata basis
a. 26.25%
b. 27.25%
c. 28.25%
2-4
a. 26.25%
66
Retirement: 2-4 Defined Benefit Pensions
Excess Method: As an example, let’s assume that Marge is a 35-year participant in a defined benefit plan that has a base benefit percentage of 10% of final average compensation. In this case, the permitted disparity would be 10% (the lesser of the base benefit percentage or the 26.25% maximum). The excess benefit percentage (the benefit applied to compensation above the covered compensation limit) would then be __%.
a. 0%
b. 10%
c. 20%
2-4
c. 20%
67
Retirement: 2-4 Defined Benefit Pensions
Excess Method: As an example, let’s assume that Marge is a 9-year participant in a defined benefit plan that has a base benefit percentage of 10% of final average compensation. In this case her permitted disparity would be the lesser of the base benefit percentage (10%) or 6.75% (.75% x 9). The excess benefit percentage would then be 16.75% (10% + 6.75%).
a. 15.75%
b. 16.75%
c. 17.75%
2-4
b. 16.75%
| 6. 75% (10% + 6.75%).
68
Retirement: 2-4 Defined Benefit Pensions
Offset Method. The offset method—is permitted only in defined benefit plans. Although the end result is the same, the offset method works differently than the excess method. A defined benefit plan using offset integration will apply the plan benefit formula to all earnings and then reduce the benefit on earnings below the covered compensation limit. The effect is to reduce a participant’s plan benefits by a percentage of the Social Security benefits he or she is expected to receive at age 65. If a defined benefit plan uses an offset permitted disparity formula, the maximum
offset allowance, or benefit reduction, is the lesser of
0.75% per year of service (up to 35); or
__% of the base benefit percentage per year of service.
a. 50%
b. 60%
c. 70%
2-4
a. 50%
In other words, by taking Social Security into account the offset method reduces the plan formula, and the employer’s plan benefit can be reduced by up to 50%.
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Retirement: 2-4 Defined Benefit Pensions
When a participant terminates with an accrued benefit or an account that is less than 100% vested, the unvested portion remains with the plan and is lost to the participant. The unvested amount lost is “forfeited” to the plan and is called a forfeiture. For example, let’s say that the fund’s actuary has determined that the company needs to contribute $100,000 to the DB plan this year in order to meet its obligations. If there were $15,000 in forfeitures because some employees left before they were fully vested and part of their benefit has been forfeited, then the company would need to contribute just $______.
a. $15,000
b. $85,000
c. $100,000
2-4
b. $85,000
70
Retirement: 2-6 Defined Benefit Pensions
Defined benefit plan sponsors may terminate their plan in one of three ways, each of which is designed to limit PBGC’s liability.
The PBGC may terminate an underfunded plan for one or more of the following reasons:
the plan is not in compliance with minimum funding standards,
the plan is unable to pay benefits when due,
the plan has unfunded liabilities following the distribution of $10,000 or more to the owner, or the potential loss to PBGC is expected to increase unreasonably if the plan is not terminated.
a. voluntary standard termination
b. voluntary distress termination
c. involuntary termination
2-6
c. involuntary termination
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Retirement: 2-6 Defined Benefit Pensions
Defined benefit plan sponsors may terminate their plan in one of three ways, each of which is designed to limit PBGC’s liability.
Plan assets are sufficient to cover benefit liabilities at the time of termination
a. voluntary standard termination
b. voluntary distress termination
c. involuntary termination
2-6
a. voluntary standard termination
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Retirement: 2-6 Defined Benefit Pensions
Defined benefit plan sponsors may terminate their plan in one of three ways, each of which is designed to limit PBGC’s liability.
An employer is in bankruptcy proceedings (such as liquidation or reorganization) or will only be able to
continue operating as a business if released from outstanding pension liabilities
a. voluntary standard termination
b. voluntary distress termination
c. involuntary termination
2-6
b. voluntary distress termination
73
Retirement 2-1 Defined Benefit Pensions
Module Check
1. Three common formulas for determining annual retirement benefits from a defined benefit plan include all of the following except
a. the flat dollar amount.
b. the flat percentage of earnings.
c. the dollar/percentage matrix.
d. the percentage of earnings per year of service (unit credit).
(LO 2-1)
c. the dollar/percentage matrix.
The dollar/percentage matrix formula does not exist.
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Retirement 2-1 Defined Benefit Pensions
Module Check
2. Which one of the following is not a characteristic of a defined benefit plan?
a. The retirement benefit is not certain; investment risk is borne by the participant.
b. Benefits are limited to the lesser of 100% of compensation or $210,000 in 2016.
c. Forfeitures may only be applied to reduce the employer’s contribution.
d. The plan requires annual actuarial determinations of contributions.
(LO 2-1)
a. The retirement benefit is not certain; investment risk is borne by the participant.
The retirement benefit is certain in a defined benefit plan.
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Retirement 2-1 Defined Benefit Pensions
Module Check
3. Which one of the following statements incorrectly describes components of defined benefit plans in 2016?
a. A defined benefit plan may define compensation to be either final average pay or career average pay.
b. The employer contribution to a defined benefit plan may be allocated to participants’ accounts in any manner, as long as 60% of the contribution is allocated to the accounts of non-highly compensated employees.
c. Compensation that may be considered in the calculations is limited to $265,000 this year.
d. The benefits of defined benefit plans are limited to the lesser of $210,000, indexed, or 100% of compensation.
(LO 2-1)
b. The employer contribution to a defined benefit plan may be allocated to participants’ accounts in any manner, as long as 60% of the contribution is allocated to the accounts of non-highly compensated employees.
These are incorrect parameters for defined benefit plans.
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Retirement 2-1 Defined Benefit Pensions
Module Check
4. Which of the following are requirements of qualified plans?
I. The plan must benefit all employees.
II. The plan must meet minimum vesting schedules.
III. The plan must not be discriminatory.
IV. The plan must be established in the U.S., and needs to be in writing.
a. I and III only
b. II and IV only
c. II, III, and IV only
d. I, II, III, and IV
(LO 2-1)
c. II, III, and IV only
There are minimum participation requirements, but the plan does not need to benefit all employees.
77
Retirement 2-3 Defined Benefit Pensions
Module Check
5. Which one of the following statements correctly describes the term “accrued benefit”?
a. the dollar amount set aside in the defined benefit plan for the employee
b. the benefit that each employee receives when they leave the company
c. the dollar amount distributed to the employee at termination of employment
d. the total benefit the participant has earned to date (This amount is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service times the benefit formula in a flat percentage benefit plan.)
(LO 2-3)
d. the total benefit the participant has earned to date (This amount is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service times the benefit formula in a flat percentage benefit plan.)
This amount is usually determined by multiplying the result of the participant’s years of service divided by the total potential years of service, times the benefit formula in a flat percentage benefit plan.
78
Retirement 2-7 Defined Benefit Pensions
Module Check
6. Which of the following annuities must be offered to a married participant at retirement?
a. qualified term-certain annuity
b. qualified optional survival annuity
c. qualified single life annuity
d. qualified survivor annuity
(LO 2-7)
b. qualified optional survival annuity
The Pension Protection Act of 2006 requires a qualified optional survivor annuity (QOSA). Most plans already provided a qualified joint and survivor annuity with a 50% benefit to the survivor; the QOSA requires a 75% benefit to the survivor.
79
Retirement 2-5 Defined Benefit Pensions
Module Check
7. Which one of the following characteristics is not shared by defined benefit plans and target benefit plans?
a. Qualified joint and survivor annuity requirements apply.
b. Minimum funding requirements apply.
c, The contribution must be made each year.
d. Excess investment earnings result in greater retirement benefits for participants.
(LO 2-5)
d. Excess investment earnings result in greater retirement benefits for participants.
Excess earnings lower future contributions in a defined benefit plan.
80
Retirement 2-1 Defined Benefit Pensions
Module Check
8. Which one of the following statements correctly describes a defined benefit plan that provides benefits under a unit-benefit formula?
a. The plan is generally not favorable for a participant with many years of service.
b. Retirement benefits are generally higher than the benefits provided under a flat-benefit formula.
c. The benefit is generally expressed as a flat amount or a flat percentage of compensation.
d. The benefit is generally expressed as a percentage of compensation per year of service.
(LO 2-1)
d. The benefit is generally expressed as a percentage of compensation per year of service.
The unit-benefit formula defines the benefit as a percentage of compensation for each year of service or participation.
81
Retirement 2-8 Defined Benefit Pensions
Module Check
9. Walton Industries Inc. provides a qualified defined benefit plan for its 82 employees. Operations have strengthened over the 10 years since the plan was installed. During the same period, employee turnover has increased to a current annual level of 60%. The performance of the defined benefit plan fund investments has exceeded original projections. The funds of the defined benefit plan are invested in several mutual funds. Which one of the following characteristics of Walton Industries or its employees would be expected to increase the amount of the retirement benefits available to plan participants?
a. Walton Industries’ increased turnover rate
b. the higher-than-projected investment performance of plan funds
c. Walton Industries’ stronger-than-projected operating performance
d. a plan amendment increasing the benefit formula
A change in the benefit formula changes retirement benefits.
(LO 2-8)
d. a plan amendment increasing the benefit formula
A change in the benefit formula changes retirement benefits.
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Retirement 2-8 Defined Benefit Pensions
Module Check
10. Marvin Roberts, age 52, is the owner of Ready-Pour Concrete Inc., a company he started 17 years ago.
The 12 rank-and-file employees of Ready-Pour range in age from 22 to 33, and they have from one to three years of service. Typically, employees remain at the company for an average of only 11⁄2 years. Marvin is considering installing a defined benefit plan to ensure his retirement security, and wants to take into account past service.
Which one of the following would apply to the installation of a defined benefit plan with a unit-benefit formula at Ready-Pour Concrete Inc.?
a. A unit credit defined benefit plan would provide a greater retirement benefit for rank-and-file employees than would a flat-benefit formula plan.
b. The plan would allow Marvin to exclude employees who have not accrued sufficient units to participate in the plan.
c. The plan would be more favorable to the younger employees than it is to Marvin.
d. The plan would be more favorable to Marvin than it is to the younger employees.
(LO 2-8)
d. The plan would be more favorable to Marvin than it is to the younger employees.
Marvin is age 52 and, thus, would benefit from the more substantial funding allowed by a defined benefit plan. In addition, if employee tenure continues to be relatively short, a unit-benefit formula allows Marvin to be credited with a significantly higher number of years of service compared to the total years for any of his employees.
83
Retirement 2-4 Defined Benefit Pensions
Module Check
11. Which of the following would not be a permitted disparity for a defined benefit plan that uses Social Security integration?
a. An excess benefit percentage of 40% if the base percentage is 20%
b. An excess benefit percentage of 60% if the base percentage is 30%
c. An excess benefit percentage of 20%, if the base percentage is 15%
d. An excess benefit percentage of 10% if the base percentage is 5%
(LO 2-4)
b. An excess benefit percentage of 60% if the base percentage is 30%
The disparity of 30% in answer b is too high. Base percentage + permitted disparity = excess benefit percentage; the permitted disparity is the base percentage, up to a maximum of 26.25%.
84
Retirement 2-1 Defined Benefit Pensions
Module Check
12. All of the following may be included under the IRS’s definition of compensation as it applies to defined benefit plans except
a. investment income
b. salaries.
c. fees for professional services.
d. salary reduction contributions
(LO 2-1)
a. investment income
Investment income is not considered compensation.
85
Retirement 2-5 Defined Benefit Pensions
Module Check
13. All of the following are true regarding the minimum funding standard except that
a. plans that do not meet the standard are subject to a 10% penalty.
b. the funding standard account is credited with contributions and charged with liabilities.
c. it determines the amount that must be contributed to the plans to provide the benefit promised by the plan.
d. it determines the amount that employees must contribute.
(LO 2-5)
d. it determines the amount that employees must contribute.
Employee contributions are not required by defined benefit plans.
86
Retirement 2-5 Defined Benefit Pensions
Module Check
14. All of the following affect retirement benefits in a defined benefit plan except
a. investment earnings on the plan’s assets.
b. the participant’s compensation.
c. the participant’s years of service.
d. the plan’s formula.
(LO 2-5)
a. investment earnings on the plan’s assets.
Investment earnings do not affect retirement benefits in a defined benefit plan. However, they would affect benefits in a defined contribution plan.
87
Retirement 2-3 Defined Benefit Pensions
Module Check
15. Which of the following statements is true about the 50/40 test?
a. If at least 40 employees are covered, then the plan passes.
b. If less than 50 employees are covered, then the plan fails.
c. If there are only three employees, then at least two must be covered.
d. If there are union employees, then they must also be considered when doing the 50/40 test calculation.
(LO 2-3)
c. If there are only three employees, then at least two must be covered.
At least 50 employees, or 40% of ERISA eligible employees, must be covered. However if there are only three employees, at least two must be covered. Union employees are already covered by their own plan, and are not ERISA eligible.
88
Retirement 2-5 Defined Benefit Pensions
Module Check
16. Which of the following variables would decrease an employer’s annual contribution in future years?
a. lower than expected rate of turnover of participants
b. higher than expected investment earnings in a defined benefit plan
c. use of salary scales by the actuary
d. use of a lower interest rate assumption by the actuary
(LO 2-5)
b. higher than expected investment earnings in a defined benefit plan
Higher than assumed investment earnings create a surplus and, thus, reduce employer contributions in future years.
89
Retirement 2-3 Defined Benefit Pensions
Module Check
17. The limitations under IRC Section 415(b) vary depending upon which of the following facts and circumstances?
a. For an employee retiring at age 60, the maximum annual retirement benefit from a defined benefit pension plan must be actuarially adjusted downward.
b. For an employee with less than 10 years of plan participation, the Section 415(b) dollar limit of $210,000 and the 415(b) 100% of compensation limitation are increased by 10% for each year of participation under 10 years.
c. For an employee with less than 10 years of service, the Section 415(b) dollar limit of $210,000, not the 415(b) 100% of compensation limitation, is increased by 10% for each year of service fewer than 10 years.
(LO 2-3)
a. For an employee retiring at age 60, the maximum annual retirement benefit from a defined benefit pension plan must be actuarially adjusted downward.
The maximum annual retirement benefit for a defined benefit pension plan must be actuarially reduced when retirement is at an age earlier than 62
90
Retirement 2-6 Defined Benefit Pensions
Module Check
18. Which of the following conditions could result in the PBGC initiating legal proceedings to terminate a qualified plan?
a. a profit sharing plan in which the company has not made any contribution for three years
b. a target benefit plan that has not paid the PBGC premium
c. if a defined benefit plan is unable to pay benefits when due
(LO 2-6)
c. if a defined benefit plan is unable to pay benefits when due
The PBGC may terminate an underfunded plan if the plan is not in compliance with minimum funding standards, the plan is unable to pay benefits when due, the plan has unfunded liabilities following the distribution of $10,000 or more to the owner, or the potential loss to PBGC is expected to increase unreasonably if the plan is not terminated.
91
Retirement 2-7 Defined Benefit Pensions
Module Check
19. Which one of the following statements is correct regarding the Pension Protection Act (PPA) of 2006?
a. The PPA was passed to address minimum contribution rules for defined benefit pension plans.
b. PPA provided for the qualified optional survivor annuity, which requires pension plans to provide a survivor annuity of 100%.
c. The PPA extended the PBGC coverage to all defined benefit and cash balance plans.
(LO 2-7)
a. The PPA was passed to address minimum contribution rules for defined benefit pension plans.
The central component of the PPA is to address the funding of defined benefit pension plans.
The PPA provided for the qualified optional survivor annuity, which requires pension plans to provide a survivor annuity of 75% in addition to the qualified joint and survivor annuity option providing at least 50%. Although PBGC insures most defined benefit plans, there are some that are not covered. For example, plans offered by “professional service employers” (such as dentists, doctors, lawyers, or financial planning practices) with fewer than 26 employees usually are not insured. Religious groups or federal, state, or local governments are also not insured.
92
Retirement 2-3 Defined Benefit Pensions
Module Check
20. Which of the following are eligibility requirements that a defined benefit plan must satisfy to qualify for tax-favored status?
I. The plan must include employees who have attained 21 years of age.
II. The plan must include employees who have given one year of service to the employer during which they have worked a minimum of 1,000 hours.
III. If the employer uses the two-year 100% rule, participation requirements may be based on completion of two years of service.
IV. An employee’s service with a predecessor must count towards years of service in a predecessor’s plan.
a. II, and III only
b. I, III, and IV only
c. I, II, and IV only
d. I, II, III, and IV
(LO 2-3)
d. I, II, III, and IV
All of these requirements must be met if the defined benefit plan is to qualify for tax-favored status.
93
Retirement 2-8 Defined Benefit Pensions
Module Check
21. The following facts apply to Jack Baker and his business, Gem Clock Corporation:
Jack is 50 and started Gem Clock about 15 years ago. He plans to retire at age 65.
The Gem Clock Corporation employee census shows that employees range in age from 27 to 46 and have from six months to six years of service.
Jack would like to install a qualified plan that favors him and rewards loyal employees.
Which one of the following is an advantage to Jack of installing a defined benefit plan with a unit-benefit formula?
a. It could maximize Jack’s benefits and give employees incentive to work harder as units of profit are allocated to their accounts.
b. It could reward older employees hired in their 50s or 60s who are nearer to retirement.
c. It would provide the largest contribution to Jack’s account since he has the most years of service.
d. It could both maximize Jack’s benefits and reward long-term employees, because benefits are based in part on length of service.
(LO 2-8)
d. It could both maximize Jack’s benefits and reward long-term employees, because benefits are based in part on length of service.
A unit-benefit formula in a defined benefit pension plan would favor employees who have accrued many years of service with the company—in this case, primarily Jack and the long-term employees he would like to reward.
94
Retirement 2-2 Defined Benefit Pensions
Module Check
22. The major distinguishing difference between a traditional defined benefit plan and a cash balance pension plan is that
a. a cash balance pension plan provides for a specified benefit at retirement.
b. cash balance pension plans typically provide higher benefits for younger employees than for older employees.
c. cash balance pension plans require the employer to be responsible for all contributions and investment risk.
d. in 2016,the maximum contribution limit for a cash balance pension plan is the amount necessary to fund benefits of up to the lesser of $210,000 or 100% of compensation averaged over the three years of highest compensation.
(LO 2-2)
b. cash balance pension plans typically provide higher benefits for younger employees than for older employees.
Unlike a traditional defined benefit plan, cash balance pension plans typically provide higher benefits for younger employees and lower benefits for older employees. This is particularly true about cash balance pension plans offered by large corporate employers.
95
Retirement 2-2 Defined Benefit Pensions
Module Check
23. Which of the following is a correct statement about contributions made to a cash balance pension plan?
a. Employee contributions are always 100% vested.
b. Annual employer contributions must reflect a uniform allocation formula based on compensation.
c. Investment performance affects the benefits paid to participants.
d. Contributions to a cash balance pension plan are limited by IRC Section 415(c) limitation of $53,000 in 2016.
(LO 2-2)
b. Annual employer contributions must reflect a uniform allocation formula based on compensation.
Annual employer contributions made to a cash balance pension plan must reflect a uniform allocation formula based on compensation paid.
96
Retirement 2-7 Defined Benefit Pensions
Module Check
24. Which of the following statements is correct regarding potential results of the Pension Protection Act (PPA) of 2006?
a. As a result of the flexibility in the new minimum funding rules, there should be a gradual increase in the number of firms using defined benefit plans.
b. Since 1985 the number of defined benefit plans has been increasing and we have seen the number of participants insured under PBGC has increased since enactment of the PPA.
c. PPA may result in an acceleration of termination of defined benefit plans.
(LO 2-7)
c. PPA may result in an acceleration of termination of defined benefit plans.
While the intent of Congress in passing PPA was to make sure more defined benefit plans were properly funded, the result may instead be the acceleration of freezing plan participation or benefit accruals under existing plans, or the outright termination of existing plans.
97
Retirement 2-2 Defined Benefit Pensions
Module Check
25. Which of the following statements correctly identifies an advantage of cash balance plans?
a. Older employees generally receive higher benefits under cash balance plans than a traditional defined benefit plan.
b. Employees get a specified retirement benefit.
c. Cash balance plans can use the same five-year cliff vesting as traditional defined benefit plans can use.
(LO 2-2)
b. Employees get a specified retirement benefit.
One benefit of a cash balance plan is employees do get a specified retirement benefit.
98
Retirement 2-2 Defined Benefit Pensions
Module Check
26. Which of the following correctly define the cash balance plan?
a. A cash balance plan is a defined contribution plan in which an actuary determines the annual contribution that the employer must make to meet the target specified in the plan design.
b. A cash balance pension plan is a defined benefit plan that provides specific annual employer contributions that accumulate at a specific annual guaranteed investment rate of return.
c. A cash balance plan is a defined contribution plan in which each participant has a hypothetical account to keep track of the annual contributions and guaranteed investment rate of return.
(LO 2-2)
b. A cash balance pension plan is a defined benefit plan that provides specific annual employer contributions that accumulate at a specific annual guaranteed investment rate of return.
99
Retirement 2-2 Defined Benefit Pensions
Module Check
27. In the event that a cash balance plan’s investment returns are lower than specified, the plan actuary adjusts
a. benefits payable to each participant.
b. the required employer contribution for the future.
c. future employee contributions.
(LO 2-2)
b. the required employer contribution for the future.
If the investment performance falls short of the expected return, the plan actuary adjusts the required employer contribution for the future.
100
Retirement 2-4 Defined Benefit Pensions
Module Check
28. An integrated defined benefit plan providing a 20% flat benefit could provide
a. an excess benefit of 26% and 40% permitted disparity.
b. a permitted disparity of 20% and excess benefit of 40%.
c. a permitted disparity of 26.5% and excess benefit of 40%.
(LO 2-4)
b. a permitted disparity of 20% and excess benefit of 40%.
A flat defined benefit plan could provide the lesser of the 20% base benefit percentage or 26.25%, and excess benefit of 20% + 20%.
101
Retirement 2-6 Defined Benefit Pensions
Module Check
29. Which of the following pension plans would be covered under the PBGC?
a. target benefit pension plan
b. a defined benefit plan maintained by a business owned by licensed professionals that have never had more than 25 active participants
c. most defined benefit and cash balance plans are covered under the PBGC
(LO 2-6)
c. most defined benefit and cash balance plans are covered under the PBGC
102
Retirement 2-6 Defined Benefit Pensions
Module Check
30. Harry is employed by ABC Dieworks, and is 60% vested in the defined benefit plan. However, ABC decided to convert to a cash balance plan, which means that Harry is
a. going to start the three-year cliff vesting with the cash balance plan.
b. still vested at 60% with the cash balance plan.
.
c. 100% vested with the cash balance plan replacing the defined benefit plan.
(LO 2-6)
b. still vested at 60% with the cash balance plan.
Harry is still 60% vested, and will continue with the same vesting schedule as the traditional defined benefit plan.
