Retirement And Employee Benefits Flashcards
What are the two types of pension plans (Are they defined benefit or contribution) and 6 types of profit sharing plans
What is the difference between a defined benefit and defined contribution plan
Defined benefit is a guaranteed payout, employer assumes investment risk, covered by teh pension benefit guaranty corp and are comingled with investment accounts.
Defined contribution is when you select what you contribute and your payout is based on that (annual contribution limit of 25% of total employee covered comp or 20% if for self-employed), employee assumes risk,
What are advantages of a qualified plan
Advantages of Qualified Plans
• “Qualified plans” under Section 401(a), provide employers with: (1) current income tax deductions and (2 payroll tax savings. They provide plan participants with (1) income tax deferrals, (2) payroll tax savings al federally provided creditor asset protection.
• The trade-offs for the tax advantages of qualified plans are the cost of the plan (both the operational expense contributions) and compliance, including vesting, funding, eligibility, nondiscrimination testing, IRS report and employee disclosure.
• Taxation of Plan Contributions
- Income Tax
• Employers receive a current income tax deduction for contributions made to plans; they are an ordinary and necessary cost of business.
• Employers are limited to a maximum of 25 percent (or as actuarially determined for defined ben plans) of the total of covered compensation paid to its employees as a contribution to a qualifie plan.
What are the advantages of a qualified plan for employee? for employer?
Employer contirbutions are tax deductible and not subject to payroll tax
Employee
Availability of pretax contributions for employees
Tax deferral of earnings and contributions, ERISA protection, lump sum distribution options
Qualified plan eligibility
later of 1 year of service or turning 21
What are the coverage tests for qualified plans
An employee is covered under a qualified retirement plan when he receives a benefit from the plan. The word benefit means an employer contribution, an accrued benefit, or simply the right to participate in the case of a 401(k) plan.
Nondiscriminatory Classification
While all “eligible” employees must be considered, not all must be covered by the plan for it to maintain its qualified status.
• However, the selection of nonexcludable employees who will benefit under a qualified retirement plan must be reasonable and established based on the facts and circumstances of the business under objective business criteria.
Coverage Tests
• The general rule for coverage is that the plan must cover at least 70% of nonhighly compensated employees (defined below). However, there are exceptions (ratio percentage test an average benefits percentage test).
Therefore, to be qualified, the retirement plan must meet at least one of the three following tests:
(1) the general safe harbor test, (2) the ratio percentage test, or (3) the average benefits test.
• In addition, Defined Benefit plans must ALSO pass an additional coverage test, know as the 50/40 test (discussed below).
Highly Compensated Employees (Very Important Definition)
• For purposes of several retirement plan test calculations, all of the “eligible” employees are further segregated into two classifications: Highly Compensated (HC) and Non-Highly Compensated (NHC). The definition of a highly compensated employee provided by the IRC is an employee who is either: a 5%+ owner or makes 155k+ (or those above this AND in the top 20%—useful for high comp firms )
What are the three tests a qualified retirement plan must just pass one of.
General safe Barbour: %of NHX covered is >= 70% (NHC is non-highly compensated )
Ratio % test: % of of NHC covered / % of HC covered >= 70%
Average benefit test
Non discriminatory and AB% of NHC / AB% of HC >= 70%
In addition to the 3 passing one of the 3 tests, what must a defined benefit plan also pass
50/40 coverage… it’s 50 non-excludible employees or 40% of all employees each day of the year must be covered
3 ways to be a key employee
: (1) a greater than five percent owner, or (2) a greater than one percent owner with compensation in excess of $150,000, or (3) an officer with compensation in excess of $220,000 (2024).
What is the minimum contribution of an employees salary must a defined contribution top heavy plan provide for NHC? For a DB?
3%
for a DB plan, it’s 2.5% x years of service
Maximum employee + employer + forfiture contribution per participant for qualified plans
For each, it is the lesser of any choices:
DC: 100% of salary or 69k (incl. 7.5k catchup for 50 years or older)
DB: 275k or 100% of average of the employees 3 highest years of service
How to be a HC employee
Salary >155k (this year or 150K last year), own 5%+
What is a profit sharing plan
A profit-sharing plan allows employers to contribute to the plan through cash or employer stock on a year-to-year basis. This plan is one of the most flexible defined contribution plans that allow the company to make annual changes to contributions based on company profits or cash flow.
What is a pension plan (describe the differences between the two types)
A defined benefit Pension plans: promises a specific monthly benefit amount upon retirement, traditionally based on factors including salary and years with the company.
A defined contribution pension plan: is funded by a specified amount contributed to the plan, with benefits based on how the investments of the amounts contributed have performed.
What is the maximum benefit a defined benefit pension plan that can be paid to an employee
the lessor of the max from the tax table or 100% of the average of highest 3 years of salary
What are the names of the formulas to calculate the employee benefit for a defined benefit plan
1) Unit benefit formula
2) Flat-percentage formula
3) Flat-amount formula
What is a cash balance pension plan? what is its vesting schedule? When is this strategically useful?
A DB pension plan that shows employees a calculated indicative cash balance of their qualified plan account balance.
better for younger people because they have more time to spend in the plan
vesting: 3 year cliff
Can convert a defined benefit plan to this. A good way to get rid of expensive DB plans (that benefit older people)
What is a money purchase pension plan? What type of employee is this plan better for and why?
A DC plan where the contribution to the plan is based on a fixed % of the employee’s compensation
All DC plans benefit younger participants (they have more time in the plan for more contributions and compounding to occur)
Excess rate with respect to social security is generally how much higher than the base rate
5.7%
Base rate + permitted disparity = excess rate
Who can make a 401k plan
Corporations
partnerships
LLC
proprietorships
tax-exempt entitites
What does ADP mean
Actual deferral percentage (how much each employee defers for retirment. Typically used in teh ADP test where you compare the total average employee actual deferral rate of HC vs NHC
How much higher is the average ADP of HC than NHC be
2%
What is the limit on loans from qualified plan
The lessor of
1) Greater of $10k or 50% of vested plan balance.
2) $50k
At any point in time.
what are the names of the two DB plans
Defined benefit and Cash balance pension plan
What is the least generous vesting schedule
3 year cliff or 2 to 6 year vesting (year 2 is 20%, year 6 is 100%)
What happens when quail plan owner dies prior to entire distribution
Write out the qualified retirement plan tree
