Retirement & Employee Benefits Flashcards
Bob Thornton received his NonQualified Stock Option (NQSO) from his company (publicly traded on the NYSE), one year ago last week, with an option exercise price and stock price of $30. He told you recently, as his trusted financial adviser, that he desperately needed cash, and so he exercised the options last week on the one year anniversary with the stock price at $40 per share, and he sold the stock as it climbed to $45 per share. What will the tax ramifications of these transactions be?
Bob will be taxed at capital gain rates only when the option is exercised and again for the difference when the stock is sold.
Bob will be taxed as W-2 income for the fair market value of the stock less the exercised price when it is exercised, and then he will be taxed at capital gain rates for the balance when the stock then subsequently sold (long or short term).
Bob will be taxed at ordinary income rates on the difference between the exercise price and the fair market value of the stock when the option is granted and then on capital gain rates when the stock is sold for the fair market value.
There are no consequences to this circumstance until Bob sells the stock with all proceeds being taxed at capital gains rates.
Solution: The correct answer is B.
He will be required to report the gain as W-2 income of $10 per share when the option is exercised and then another $5 capital gain (long or short) when sold as the question indicates.
For tax determination purposes, the holding period of a nonqualified option is determined to begin by which of the following?
On the date the transferee becomes eligible for the grant.
On the date of sale.
On the date of the grant.
On the date of exercise.
Solution: The correct answer is D.
The security holding period in the case of a non-qualified options begins on the date the option is exercised.
David is awarded an immediately vested, non-qualified stock option for 1,000 shares of company stock with an exercise price of $35 per share while the stock price is currently $33 per share. What are the tax ramifications, if any at the date of the grant?
$0
The gain between exercise and actual price of $2,000 is immediately taxable.
The awarded option price value of $33,000 will be immediately taxable.
Because these are unrealized gains, neither the option value nor the gain are taxable until the stock is finally sold.
Solution: The correct answer is A.
In the case of NQS Options, the option is not taxed at the grant if the exercise price is equal to or greater than the fair market value of the stock.
Which of the following statements regarding ISOs and NQSOs is correct?
The tax treatment of a cashless exercise of an ISO is the same as the cashless exercise of a NQSO.
One of the disadvantages of an ISO is that the sale of the stock attributable to an ISO may result in the taxpayer paying alternative minimum tax.
IRC 409A provides harsh penalties when a company grants an ISO or NQSO with a strike price that exceeds the current FMV of the employer’s tax.
To the extent that the aggregate fair market value of stock with respect to which incentive stock options are exercisable for the 1st time by any individual during any calendar year exceeds $100,000, such options shall be treated as options which are not incentive stock options.
Solution: The correct answer is D.
Choice a is not correct as the tax treatment is not the same for a cashless exercise of an ISO and an NQSO. ISO is not subject to payroll tax, NQSO is subject to payroll tax. They will be the same for income tax; both ordinary income. Choice b is not correct. The sale of an ISO share of stock will generally have a negative adjustment for AMT, not positive, and therefore, it would not result in AMT. Choice c is not correct as 409A would apply if the strike price was less than the FMV on the date of grant.
Eric works for Carpets, Inc. Carpets, Inc issued him both ISOs and NQSOs during the current year. Which of the following would be the most compelling reason why they might issue both ISOs and NQSOs?
They want to issue over $80,000 in options that are exercisable in the same year.
The NQSOs and ISOs are exercisable in different years.
The company wants to provide the NQSOs to assist the individual in purchasing the ISOs.
Since they are virtually the same there is no compelling reason to issue both in the same year.
Solution: The correct answer is C.
When both ISOs and NQSOs are available in the same year the individual can exercise and sell the unfavored NQSOs to generate enough cash to purchase and hold the favored ISOs. It would also be valuable to have both if they issued over $100,000 in options exercisable in the same year because there is a $100,000 limit on ISOs
Bob Jones is a senior executive at Sys, a global outsourcing firm based in New York. The company has recently rolled out a new compensation program that includes non-qualified stock options. Bob has approached you, as his planner, with several questions about the tax impact involved in his nonqualified (non-statutory) stock options. His circumstance is as follows:
February 1st: he was granted an option when the company stock price was $30. His option exercise price was $30, but option value was not readily ascertainable.
August 1st: he exercised the option when the stock price was $50.
September 1st: with the price at $50 per share and seeming to have peaked, Bob is wondering if he should sell the stock.
Which of the following applies?
Bob will have ordinary income of $50 if he sells at a stock price of $50.
Bob will have ordinary income at exercise, based on the spread between the stock price and the exercise price of the option.
Bob will have long-term capital gain income of $20 if he sells the stock on September 1st at a price of $50.
Bob will have ordinary income of $30 when the option is awarded.
Solution: The correct answer is B.
Bob will not be taxed for gain upon the award of the option because of the lack of readily ascertainable value. He will be taxed at exercise on the spread between the stock price of $50 and exercise price of $30, and finally, upon sale of the stock for any additional amounts of gain.
When would you advise a person not to wait to exercise a nonqualified stock option?
When long-term price appreciation is anticipated, but uncertainty regarding future stock price remains.
When the individual has had an excellent year resulting in much higher than expected income.
When the price of the stock in the market is out-of-the-money and not expected to enter or change any time soon.
When the stock price seems to have peaked and sale will immediately follow exercise.
Solution: The correct answer is D.
If all gain has been apparently made in a security, rather than lose the profit, and since there are no special advantages to holding non-qualifieds, it may be the time to exercise and to follow with an immediate sale. The rest of the options are actually reasons for holding the option without exercising it.
Which of the following is true regarding qualified incentive stock options?
No taxable income will be recognized by the employee when the qualified option is granted or exercised.
The income from sale of the qualified option will always be taxed as capital gains when the stock is sold.
The income from sale of the qualified option will be taxed as ordinary income regardless of when the stock is sold.
The employer will not be able to deduct the bargain element of the option as an expense under any circumstance.
For favorable tax treatment the option must be held two years and the stock for one year after exercise.
II and IV only.
I and V only.
III only.
I, II and V only.
Solution: The correct answer is B.
In Statement “II,” be careful of “always”! In Statement “III,” if held longer than one year, they receive capital gains treatment. In Statement “IV,” under most circumstances, the bargain element is deductible. There are exceptions when certain qualifications have not been met for deductibility, such as time employed, time to exercise in excess of rules, etc.
Which one of the following incidental benefit rules apply to life insurance coverage provided by a profit sharing plan?
Permanent life insurance, accident insurance, or severance benefits may be included as part of the coverage.
The 25% incidental benefit cost rule is based on the portion of the premium allocated to the policy’s cash value.
An employee’s costs associated with the purchase of life insurance represent a non-deductible expense.
The cost of whole life insurance must be not more than 50% of the total employer contribution allocated to a participant’s account.
Solution: The correct answer is D.
Only life insurance may be included in a qualified retirement plan - no accident, severance, or health benefits may be offered under the incidental benefit rules. To qualify under the incidental benefit rules, the entire premium for universal life cannot exceed 25% of the employer’s aggregate contributions, and 50% for whole life insurance. Any pension contributions used to purchase life insurance inside a qualified plan are deductible to the employer.
In determining the allowable annual additions per participant to a defined contribution pension plan account for the current year, the maximum contribution is:
Contribution up to $57,000 (indexed).
Compensation up to $285,000.
Compensation not exceeding the defined benefit Section 404 plan limitations in effect for that year.
100% of all salary and bonuses at all income levels.
Solution: The correct answer is A.
Option “B” addresses maximum includable compensation, which is not what the question asks. Option “C” is incorrect in mentioning Section 404. The DC plan regulations are addressed in Section 415. Finally, Option “D” is incorrect because not “ALL” salary is included in allowable contributions. There is an annual additions cap of $57,000, making Option “A” the correct response.
Which of the following characteristics are found in both a defined contribution plan and a defined benefit plan?
Individual accounts.
Actuarial assumptions required.
Retirement benefits based on account values.
Employer bears investment risk.
I only.
II and IV only.
I, III and IV only.
None of the above.
Solution: The correct answer is D.
Statements “I” and “III” apply to defined contribution plans. Statements “II” and “IV” apply to defined benefit plans. None apply to both defined benefit and defined contribution plans
Which of the following is not a requirement for the owner of corporate stock who sells to an ESOP to qualify for the nonrecognition of gain treatment?
The ESOP must own at least 55% of the corporation’s stock immediately after the sale.
The owner must reinvest the proceeds from the sale into qualified replacement securities within 12 months after the sale.
The ESOP may not sell the stock within three years of the transaction unless the corporation is sold.
The owner must not receive any allocation of the stock through the ESOP.
Solution: The correct answer is A.
The ESOP must own at least 30% of the corporation’s stock immediately after the sale. All of the other statements are true.
Cody is considering establishing a 401(k) for his company. He runs a successful video recording and editing company that employs both younger and older employees. He was told that he should set up a safe harbor type plan, but has read on the Internet that there is the safe harbor 401(k) plan and a 401(k) plan with a qualified automatic contribution arrangement. Which of the following statements accurately describes the similarities or differences between these types of plans?
The safe harbor 401(k) plan has more liberal (better for employees) vesting for employer matching contributions as compared to 401(k) plans with a qualified automatic contribution arrangement.
Both plans provide the same match percentage and the same non-elective contribution percentage.
Employees are required to participate in a 401(k) plan with a qualified automatic contribution arrangement.
Both types of plans eliminate the need for qualified matching contributions, but may require corrective distributions.
Solution: The correct answer is A.
Safe harbor plans require 100% vesting, while 401(k) plans with QACAs require two year 100% vesting. The matching contributions are different for the plans. Employees are not required to participate in either plan. Both plans eliminate the need for ADP testing, which means that they eliminate the need for qualified matching contributions and corrective distributions.
Hiroko, age 54, works for Alpha Corporation and Delta Corporation. Alpha and Delta are both part of the same parent-subsidiary control group. Alpha and Delta both sponsor a 401(K) plan. If Hiroko earns $75,000 at Alpha and $30,000 at Delta what is the maximum employee elective deferral he can make to both plans in total?
$19,500
$26,000
$39,000
$57,000
Solution: The correct answer is B.
An individual can defer up to $19,500 (2020) plus an additional $6,500 (2020) catch up for all of their 401(K) and 403(b) plans combined. In this case he can defer the entire $26,000 between the two plans.
Timothy is covered under his employer’s Defined Benefit Pension Plan. He earns $500,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 2%. He has been with the employer for 25 years. What is the maximum contribution that can be made to the plan on his behalf?
$137,700
$230,000
$285,000
It is indeterminable from the information given.
Solution: The correct answer is D.
Read the question carefully. The question asks “what is the maximum contribution that can be made.” Remember that for a defined pension plan the contribution must be whatever the actuary determines needs to be made to the plan.
Which of the following are basic provisions of an IRC Section 401(k) plan?
Employee elective deferrals are exempt from income tax withholding and FICA / FUTA taxes.
Employer’s deduction for a cash or deferred contribution to a Section 401(k) plan cannot exceed 25% of covered payroll reduced by employees’ elective deferrals.
A 401(k) plan cannot require, as a condition of participation, that an employee complete a period of service greater than one year.
Employee elective deferrals may be made from salary or bonuses.
I and III only.
I and IV only.
II and IV only.
II, III and IV only.
Solution: The correct answer is D.
Statement “I” is incorrect because all CODA plans, including 401(k) plans, subject the income to Social Security and Medicare tax even though Federal and state income tax is deferred by placing the income into the plan.
Statements “II”, “III” and “IV” are accurate.
Note: Statement III is true. A 401k cannot require 2 years of service before participation. The 2 years of service rule is for Qualified plans other than 401k. A 401k can require 2 years service for employer matching, not employee participation. All employees age 21 with 1 year of service can participate.
In 2020, the Section 415 limit for defined contribution plans is:
$19,500
$57,000
$230,000
$285,000
Solution: The correct answer is B.
Answer “A” is employee contribution . Answer “C” is top-heavy key-employee maximum and Answer “D” is the annual compensation limit.
Cash Balance and Money Purchase Pension Plans favor who?
Younger entrants.
Defined Benefit and Target Benefit Pension Plans favor who?
Older age entrants with less time to accumulate, and therefore, require higher funding levels.
Corey is covered under his employer’s Profit-Sharing Plan. He currently earns $500,000 per year. The plan is top heavy. The employer made a 5% contribution on behalf of all employees. What is the company’s contribution for him?
$14,250
$25,000
$57,000
$285,000
Solution: The correct answer is A.
For a profit sharing plan the contribution is limited to the lesser of $57,000 (2020) or covered compensation. In this case the contribution will be limited by the covered compensation limit of $285,000. $285,000 × 5% = 14,250 (the calculation without the compensation cap would have been 500,000 x 5% = 25,000). The fact that the plan is top heavy is irrelevant since all employees are receiving a contribution greater than 3%.
Jeb, age 54, works for Gamma Corporation and Epsilon Corporation. Gamma and Epsilon are both part of the same parent-subsidiary control group. Gamma and Epsilon both sponsor a 25% money purchase plan. If Jeb earns $200,000 at Gamma and $30,000 at Epsilon what is the maximum employer contribution that can be made to both plans?
$57,000
$57,500
$63,500
$81,000
Solution: The correct answer is A.
Because the two companies are part of the same controlled group they will be required to aggregate both plans. Therefore, he will be limited to the defined contribution limit of $57,000. (25% of $230,000 is $57,500 but the single employer limit applies and is $57,000 (2020)). The employer does not contribute the catch-up amount, the taxpayer would that in a contributory plan, which a Money Purchase Plan is not.
Matt is a participant in a profit sharing plan which is integrated with Social Security. The base benefit percentage is 6%. Which of the following statements is/are true?
The maximum permitted disparity is 100% of the base benefit level or 5.7%, whichever is lower.
The excess benefit percentage can range between 0% and 11.7%.
Elective deferrals may be increased in excess of the base income amount.
The plan is considered discriminatory because it gives greater contributions to the HCEs.
I and II only.
I, II and IV only.
II only.
I, II, III and IV.
Solution: The correct answer is A.
His base rate is 6% and the social security maximum disparity is 5.7% for 11.7% as the top of his range.
Statement “III” is incorrect because integration does not affect voluntary deferrals by employees. Statement “IV” is incorrect because, done properly, integration is NOT considered discriminatory.
Hot Dog Moving Company (HDM) sponsors a 401(k) profit sharing plan. In the current year, HDM contributed 20% of each employee’s compensation to the profit sharing plan. The ADP of the 401(k) plan for the NHC is 2.5%. Alex, who is age 57, earns $177,778 and owns 7.5% of the company stock. What is the maximum amount that he may defer into the 401(k) plan for this year?
$6,500
$11,000
$14,500
$16,500
Solution: The correct answer is C.
Alex is highly compensated because he is more than a 5% owner, so the maximum that he can defer to satisfy the ADP Test requirements is 4.5% (2.5% + 2%) and because he is over 50, he can defer the additional $6,500 (2020) as a catch-up contribution. Alex can defer $8,000 (4.5% × $177,778) and $6,500 (the catch-up) for a total of $14,500.
Paul is considering establishing a defined benefit plan for his company, Viking. He has a blend of highly compensated employees and rank and file employees, who have varying income levels. After doing some research, he wants to know which of the following formulas he is not permitted to use.
Base the benefit on the years of service and salary level of employees, while taking into consideration some of the benefits of Social Security.
Base the benefit retirees receive on a fixed percentage of every employee’s salary, limited to the annual compensation limit.
Define the benefit for retirees as a fixed dollar amount, regardless of income level.
He could use any of the above choices.
Solution: The correct answer is D.
All of the above are benefit formulas used by defined benefit plans.
Dr. Dylan James is a 55-year-old Doctor who just started his gastroenterologist practice and hired Nurse Nancy, who is age 25. Dr. DJ is expected to earn annual income of $350,000 that will increase at least at the rate of inflation. Inflation is expected to be 3 percent. Which of the following defined benefit plan formulas would you recommend if Dr. DJ wants to maximize his benefits in retirement, which is expected to occur at age 65?
Unit benefit (a.k.a. percentage-of-earnings-per-year-of-service) formula.
Flat-percentage formula.
Flat-amount formula.
New comparability formula.
Solution: The correct answer is B.
The unit credit formula rewards many years of service. The flat percentage formula will work well, as long as the Doctor has ten years of service. The maximum benefits under IRC 415(b) are reduced for participation less than 10 years. The flat amount would provide higher benefits for Nurse Nancy compared to Dr. DJ on comparative basis. A new comparability plan is a profit sharing plan.
Which of the following are legal requirements for 401(k) plans?
Employer contributions do not have to be made from profits.
Employee elective deferral elections must be made before the compensation is earned.
Hardship rules allow in-service withdrawals which are not subject to the 10% early withdrawal penalty.
ADP tests can be avoided using special safe harbor provisions.
I, II and IV only.
I, III and IV only.
II, III and IV only.
I, II, III and IV.
Solution: The correct answer is A.
Hardship withdrawals are considered premature withdrawals and are subject to income tax and the 10% early withdrawal penalty if the employee is under age 59 1/2.
Marilyn Hayward is the sole proprietor and only employee of unincorporated Graphics for Green Promotions. In 2020. Marilyn established a profit sharing Keogh plan with a 25% contribution formula. As of December 31, 2020, Marilyn has $140,000 of Schedule C net earnings. The deduction for one-half of the self-employment tax is, therefore, $9,891. What is the maximum allowable Keogh contribution that Marilyn can make?
$19,500
$24,311
$26,022
$32,560
Solution: The correct answer is C.
Half of the self-employment tax is given, you can skip the 1st step in the self-employment contribution formula (multiplying by 92.35%)
140,000 - $9,891 = 130,109 x 20%*= 26,021.80
*The 20% is from the contribution rate formula: contribution rate / (1 + contribution rate) = self-employment contribution rate
.25/ (1+.25) = .20. Note that if the employer has employees and contributes 15% for them, that is the contribution rate to use in this formula.
Gia, age 45, is married and has two children. Her employer, Print, Inc sponsors a target benefit plan in which she is currently covered under. Which of the following statements is true regarding her plan?
She can name anyone she wishes as her beneficiary.
A target benefit plan favors younger employees.
A target benefit plan is covered under PBGC.
The investment risk is on the employee.
Solution: The correct answer is D.
The investment risk is on the employee because this is a defined contribution plan. She can only name someone other than her spouse if she has a valid waiver signed by the spouse. This applies to all pension plans. A target benefit plan favors older entrants. A target benefit is not covered under PBGC.
An actuary establishes the required funding for a defined benefit pension plan by determining:
The lump sum equivalent of the normal retirement life annuity benefit of each participant.
The amount of annual contributions needed to fund single life annuities for the participants at retirement.
The future value of annual employer contributions until the participant’s normal retirement date, taking an assumed interest rate, the number of compounding periods, and employee attrition into account.
The amount needed for the investment pool to fund period certain annuities for each participant upon retirement.
Solution: The correct answer is B.
Statement “A” is incorrect because it deals with a lump sum, NOT annual contributions. Statement “C” is incorrect because DB plans deal with present value calculations, not future values. Statement “D” is incorrect because DB plans deal with life annuities, NOT period certain annuities
Which of the following apply to legal requirements for a qualified thrift/savings plan?
Participants must be allowed to direct the investments of their account balances.
Employer contributions are deductible when contributed.
In-service withdrawals are subject to financial need restrictions.
After-tax employee contributions cannot exceed the lesser of 100% of compensation or $57,000.
Solution: The correct answer is D.
This correctly describes the Section 415(c) limits on maximum contributions permitted by law. Participants do not have to be given the right to direct their investments. Employees make after-tax contributions to a thrift; employers don’t make contributions. Answer “C” is incorrect because only 401(k) plans have statutory hardship withdrawal requirements, not thrift/savings plans.
The investment portfolio for a defined-benefit retirement plan has declined in value during a year in which most financial market instruments have also incurred losses. Which one of the following entities would be impacted most by this decline in portfolio value?
Individual participants in the plan.
Company sponsoring the plan.
Investment advisory handling the plan assets.
Plan underwriters.
Solution: The correct answer is B.
The company may be required to make increased contributions to fully fund the plan.
The maximum retirement benefit a participant in a target-benefit plan will actually receive depends on the:
Initial actuarial computation according to the plan’s formula.
Amount of contributions determined in reference to the targeted benefit.
Maximum annual additional amounts.
Value of the participant’s account at retirement.
Solution: The correct answer is D.
While Answers “A”, “B” and “C” help to increase the final account value, the retirement benefit is determined solely by the account value.
Calculate the maximum contribution (both employer and employee elective deferrals) for an employee (age 39) earning $290,000 annually, working in a company with the following retirement plans: a 401(k) with no employer match and a money-purchase pension plan with an employer contribution equal to 12% of salary.
$19,500
$34,200
$53,700
$57,000
Solution: The correct answer is C.
For the purposes of this calculation, the compensation exceeding $285,000 is not recognized. The employer is contributing 12% of $285,000 (or $34,200) for the money purchase plan and the employee may contribute up to $19,500 in 2020 to the 401(k) plan. This totals $53,700.
In order to be qualified, money purchase plans must contain which of the following?
A definite and non-discretionary employer contribution formula.
Forfeitures can be reallocated to the remaining participants’ accounts in a non-discriminatory manner or used to reduce employer contributions.
An individual account must be maintained for each employee of employer contributions.
The normal retirement age must be specified.
I and II only.
II and IV only.
I, II and III only.
II, III and IV only.
Solution: The correct answer is C.
A normal retirement age must be stated in a defined benefit plan, so Statement “IV” is incorrect. Defined contributions plans (such as a money purchase plan) have retirement benefits which are determined by the value of the individual account whenever the participant retires. Forfeitures may be allocated to employees’ individual accounts or used to reduce employer required contributions.
In a money purchase plan that utilizes plan forfeitures to reduce future employer plan contributions, which of the following components must be factored into the calculation of the maximum annual addition limit?
Forfeitures that otherwise would have been reallocated.
Annual earnings on all employer and employee contributions.
Rollover contributions for the year.
Employer and employee contributions to all defined contribution plans.
I, II and III only.
I and III only.
II and IV only.
IV only.
Solution: The correct answer is D.
Annual additions are defined as new money contributed into the individual account of a participant. Because forfeitures reduced employer contributions and not added directly to employee’s individual accounts, the forfeitures are not included in annual additions. Annual earnings and rollover contributions are not included in annual additions.
Which of the following legal requirements apply to Employee Stock Ownership Plans (ESOPs)?
ESOPs must permit participants, who are aged 55 or older and who have at least 10 years of service, the opportunity to diversify their accounts.
ESOPs can be integrated with Social Security.
An employer’s deduction for ESOP contributions and amounts made to repay interest on an ESOP’s debt cannot exceed 25% of the participant’s payroll.
The mandatory 20% income tax withholding requirement does not apply to distributions of employer stock from an ESOP.
I and II only
II and IV only
I, II and III only
I and IV only
Solution: The correct answer is D.
Deductions for interest payments are not limited for ESOP plans. Deductions for repayment of principal is limited to 25% of covered compensation.
Which statement(s) is/are true regarding qualified profit-sharing plans?
A company must show a profit in order to make a contribution for a given year.
A profit-sharing plan is a type of retirement plan and thus is subject to minimum funding standards.
Forfeitures in profit-sharing plans must be credited against future years’ contributions.
Profit-sharing plans should make contributions that are “substantial and recurring.”
IV only.
I and III only.
I, II and IV only.
I, II, III, and IV.
Solution: The correct answer is A.
Profits are not required to make contributions to a profit-sharing plan. Minimum funding is required only in pension plans. Forfeitures may be reallocated to remaining employee accounts.
Which statement(s) is/are true for a target benefit plan?
It favors older participants.
It requires annual actuarial assumptions.
The maximum deductible employer contribution is 25% of covered compensation.
The maximum individual allocation is the lesser of 100% of pay or $57,000 (2020).
I and IV only.
II and III only.
I, III and IV only.
I, II, III and IV only.
Solution: The correct answer is C.
Actuarial assumptions are needed at the inception of the plan to provide the target formula.
Lisa, age 35, earns $175,000 per year. Her employer, Reviews Are Us, sponsors a qualified profit sharing 401(k) plan, which is not a Safe Harbor Plan, and allocates all plan forfeitures to remaining participants. If in the current year, Reviews Are Us makes a 20% contribution to all employees and allocates $5,000 of forfeitures to Lisa’s profit sharing plan account, what is the maximum Lisa can defer to the 401(k) plan in 2020 if the ADP of the non-highly employees is 2%?
$7,000
$13,500
$17,000
$19,500
Solution: The correct answer is A.
The maximum annual addition to qualified plan accounts is $57,000. If Reviews Are Us contributes $35,000 ($175,000 × 20%) to the profit sharing plan and Lisa receives $5,000 of forfeitures, she may only defer $17,000 ($57,000 - $35,000 - $5,000) before reaching the $57,000 limit (2020). However, she will also be limited by the ADP of the non-highly employees because she is highly compensated (compensation greater than $130,000). If the non-highly employees are deferring 2% then the highly compensated employees can defer 4% (2×2=4). Therefore, she is limited to a deferral of $7,000 ($175,000 × 4%).
Carol, age 55, earns $200,000 per year. Her employer, Reviews Are Us, sponsors a qualified profit sharing 401(k) plan, which is not a Safe Harbor Plan, and allocates all plan forfeitures to remaining participants. If in the current year, Reviews Are Us makes a 18% contribution to all employees and allocates $7,000 of forfeitures to Carol’s profit sharing plan account, what is the maximum Carol can defer to the 401(k) plan in 2020 if the ADP of the non-highly employees is 1%?
$4,000
$19,500
$10,500
$26,000
Solution: The correct answer is C.
The maximum annual addition to qualified plan accounts is $57,000. If Reviews Are Us contributes $36,000 ($200,000 × 18%) to the profit sharing plan and Carol receives $7,000 of forfeitures, she may only defer $14,000 ($57,000 - $36,000 - $7,000) before reaching the $57,000 limit. However, she will also be limited by the ADP of the non-highly employees because she is highly compensated (compensation greater than $130,000). If the non-highly employees are deferring 1% then the highly compensated employees can defer 2% (1×2=2). Therefore, she is limited to a deferral of $4,000 (200,000 x 2%). Since she is 50 or older she can also defer the catchup amount of $6,500 which is not subject to the ADP limitation. Therefore, her maximum deferral is $10,500.
Select those statements which accurately reflect characteristics of defined contribution pension plans?
Allocation formula which is indefinite.
Account value based benefits.
Employer contributions from business earnings.
Fixed employer contributions based upon terms of plan.
I and II only.
II and III only.
II and IV only.
I, II and III only.
Solution: The correct answer is C.
Defined contribution pension plans must have a definite allocation formula based upon salary and/or age or any other qualifying factor. Contributions may be made without regard to company profits and, because it is a pension plan, are fixed by the funding formula and must be made annually.
Richard is covered under his employer’s Defined Benefit Pension Plan. He earns $200,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 3%. He has been with the employer for 25 years. What is the maximum defined benefit that can currently be used to determine contributions?
$57,000
$150,000
$230,000
$285,000
Solution: The correct answer is B.
The maximum defined benefit is the lesser of $230,000 (2020) or his compensation. However, the funding formula will limit his defined benefit to $150,000 (25 × 200,000 × .03).
A qualified money purchase pension plan contribution (by the employer) is influenced by which of the following factors:
Total return on portfolio assets.
Forfeitures from non-vested amounts of terminated employee accounts.
Increases in participants’ compensation due to inflation or performance-based bonuses.
Minimum funding as determined by an actuary.
I and II only.
II and III only.
III and IV only.
II, III and IV only.
Solution: The correct answer is B.
Forfeitures may reduce employer contributions due to contribution offsets or Section 415 limitation on annual additions. Increased compensation will result in increased contributions by the employer, subject to Section 415 limitations. Returns on portfolio assets and actuary funding are a concern in defined benefit plans. A money purchase plan is defined contribution plan.
Robin just started at Financial University Network (FUN) and has been encouraged by several of the “old timers” to save part of her salary into the 401(k) plan. She is not yet convinced as she likes to shop. Which of the following statements is accurate regarding 401(k) plans?
A 401(k) plan must allow participants to direct their investments.
Deferrals into the 401(k) plan must be contributed by the end of the following calendar quarter into the plan.
Employees that join the plan must be provided with a summary plan description.
A 401(k) plan is financially safe because it must have an annual audit.
Solution: The correct answer is C.
Answer c is correct as employees must be given a summary plan description, which provides basic information about the operation of the plan. Answer a is not correct as some 401(k) plans may have the asset managed by an investment manager. However, most 401(k) plans will provide for employee self directing of their 401(k) balances. Answer d is not correct as there is no requirement for an annual audit of a 401(k) plan.
James is covered under his employer’s top heavy Defined Benefit Pension Plan. He currently earns $120,000 per year. The Defined Benefit Plan uses a funding formula of Years of Service × Average of Three Highest Years of Compensation × 1.5%. He has been with the employer for 5 years. What is the maximum defined benefit that can be used for him for funding purposes?
$9,000
$12,000
$54,000
$120,000
Solution: The correct answer is B.
The maximum defined benefit is the lesser of $230,000 (2020) or his compensation. However, the funding formula will limit his defined benefit to $12,000 (5 × 120,000 × .02). Note that you would use 2% instead of the 1.5% because the plan is top heavy. He is not a key employee because he is not a 1) greater than 5% owner, 2) greater than 1% owner with compensation greater than $150,000 or 2) an officer with compensation greater than $185,000 (2020). Therefore the plan must use a defined benefit limit of 2% instead of 1.5%.
All of the following accurately reflect the characteristics of a stock bonus plan, except:
Useful in cash flow planning for plan sponsor due to cashless contributions.
Provides motivation to employees because they become “owners.”
20% withholding does not apply to distributions of employer securities and up to $200 in cash.
May not allow “permissible disparity” or integration formulas.
Solution: The correct answer is D.
Integration formulas are not allowed under an ESOP plan but are allowed under a stock bonus plan. All other statements are accurate in their description of a stock bonus plan.
Shane’s Rib Shack has a Target Benefit Plan. They have 10 employees with the following compensations: Employee Compensation
$300,000 $100,000 $75,000 $50,000 $50,000 $50,000 $50,000 $25,000 $25,000 $20,000 Based on the actuarial table that was established at the inception of the plan they should fund the plan with $210,000. What is the maximum deductible contribution that can be made to the plan?
$182,500
$186,250
$195,000
$210,000
Solution: The correct answer is A.
Since the plan is a defined contribution plan the maximum deductible contribution is 25% of the total covered compensation. The max covered compensation of all employees is $730,000. Thus the maximum deductible limit is $182,500 ($730,000 × 25%). Remember to limit employee 1 to the $285,000 (2020) covered compensation limit. The actuarial table amount is irrelevant because this a defined contribution plan.
Which of the following statements accurately reflects the overall limits and deductions for employer contributions to qualified plans?
An employer’s deduction for contributions to a money purchase pension plan and profit sharing plan is limited to the lesser of 25% of covered payroll or the maximum Section 415 limits permitted for individual account plans.
An employer’s deduction for contributions to a defined benefit pension plan and profit sharing plan cannot exceed the lesser of the amount necessary to satisfy the minimum funding standards or 25% of covered payroll.
Profit sharing minimum funding standard is the lesser of 25% or the Section 415 limits permitted for individual account plans.
I only.
I and II only.
II and III only.
I, II and III.
Solution: The correct answer is A.
Statement “II” is incorrect because there is no 25% of covered payroll limitation in a DB plan. Statement “III” is incorrect because there is no minimum funding standard for profit sharing plans.
Which one of the following statements is NOT correct?
Profit sharing plans fall under the broad category of defined contribution plans.
Profit sharing plans are best suited for companies that have unstable earnings.
A company that adopts a profit sharing plan is required to make contributions each year.
The maximum tax deductible employer contribution to a profit sharing plan is 25% of covered compensation.
Solution: The correct answer is C.
Minimum funding (mandatory annual contributions) are a characteristic of pension plans, not profit sharing plans.
Which of the following characteristics apply to paired plans (also known as “tandem plans”)?
Generally combines a money purchase pension and a profit-sharing plan.
Actuarial assumptions required.
Total contributions to the paired plans limited to 15% of payroll by IRC Section 404.
Employer bears investment risk.
I only.
II and IV only.
I, III and IV only.
IV only.
Solution: The correct answer is A.
Defined contribution plans do not require actuarial assumptions. Total contributions to both plans is limited to lesser of 100% or $57,000 (2020) by IRC Section 415. The profit sharing plan is limited by IRC Section 404 to 25% of covered payroll. Employees bear the investment risk in DC plans.
Which of the following is NOT included as one of the provisions for the continuation benefits under the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985?
All employers offering group health insurance must provide COBRA continuation benefits.
COBRA benefit durations vary from 18, 29, or 36 months depending upon the qualifying event.
COBRA eligible coverages do include: dental plans, vision plans, Medical FSAs, prescription drug plans and mental health plans.
COBRA eligibility ceases when a covered participant becomes eligible to participate in another group health plan or Medicare.
Solution: The correct answer is A.
COBRA benefits are required of employers who have 20 or more employees. Employers with fewer employees are not required to provide COBRA continuation, even if they offer a group a health insurance plan to employees.
Which of the following accurately describes the benefits of a Section 125 Cafeteria Plan?
Cafeteria plans provide family benefits which are homogenous.
Under a cafeteria plan, a family can effectively create its own benefit plan by the rational selecting of options available.
The law requires the employer to offer at least three options that provide cash benefits.
The law requires that at least two statutory non-taxable benefits be available.
Solution: The correct answer is B.
Family benefit needs are rarely homogenous, but vary from family to family. These unique family needs are met though a cafeteria plan because each family can tailor their benefit package to best meet those needs. Cafeteria plans, by law, must offer at least one taxable “cash” benefit, and one “pre-tax” benefit. The only tax deferral option allowed under Section 125 cafeteria plan is a 401(k). This is a statutory restriction.
Which of the following is/are accurate of a Section 125 cafeteria plan?
30% of the total benefits can accrue to key employees.
There must be at least one cash benefit.
Deferral of income is not allowed except through a 403(b).
Salary reductions can be changed at any time during the year.
I only.
II only.
II and III only.
I and IV only.
Solution: The correct answer is B.
Statement “I” is incorrect because only 25% of the total benefits can accrue to key employees. Statement “III” is incorrect because deferrals are allowed only through a 401(k) plan. Statement “IV” is incorrect because mid-year changes in reductions are allowed only for qualified changes in status.
