Retirement Planning _ Pension Plans & Profit Sharing Plans

Question 1

What are the 4 types of pension plans?

DB (2), DB (2)

Answer 1

DB
1. DB Pension Plans
2. Cash Balance Pension Plans

DC
1. Money Purchase Pension Plans
2. Target Benefit Pension Plans

Question 2

What is the common pension plan benefit formula?

Answer 2

Annual Pension Benefit Amount =

1.5% per year X # of Years of Service X Avg of 3 Highest Consecutive Years Salary

Question 3

What are DC plan restrictions or requirements?

Answer 3

In-service withdrawals limited, now available if 59-1/2 or older as phased retirement.

Limited investment in ER securities (10% max). Must have at least 3 investment choices.

Limited investment in life insurance. Must pass either (1) 25% test or (2) the 100-to-1 ratio test.

Question 4

What is the 25% test for DC plans?

Answer 4

Consists of two tests: (1) 25% test and (2) 50% test
- test used depends on type of life insurance used by the plan
- aggregate premiums paid cannot exceed X% of ER’s aggregate contributions to the participant’s account
- term or UL life insurance: 25%
- whole life insurance: 50%

** entire value of life insurance contract must covert into cash or periodic income at or before retirement

Question 5

What is the 100-to-1 ratio test for DC plans?

Answer 5

Limits the amount of death benefit of life insurance coverage purchased to 100X the monthly-accrued retirement benefit provided under the same qualified plan’s defined benefit formula

Question 6

What are the characteristics of Defined Benefit vs. Defined Contribution Plans?

Answer 6

Question 7

What are the features of a Cash Balance Pension Plan?

Answer 7

Specific defined retirement benefits

Formula using Pay Credit (may integrate with social security) and an Interest Credit

Plan sponsor responsible for investments

Favors younger participants w/ longer time horizon

3-year vesting cliff

** POPULAR CHOICE TO GET RID OF OLD EXPENSIVE DB PLANS **

Question 8

What are the features of a Money Purchase Pension Plan?

Answer 8

DC plan w/ annual contributions as a fixed percentage of EE’s compensation

ER promises to make a specified contribution but not required to guarantee a specific retirement benefit

Contribution limits either 100% EE compensation or $66,000 (2023)

Participants have separate accounts

Benefits younger participants w/ longer time horizon

2-to-6-year graduated or 3-year-cliff vesting schedules

Question 9

What are the features of a Target Benefit Pension Plan?

Answer 9

Special type of money purchase pension plan

Determines the contribution to participant’s account based on target retirement benefit

One-time actuary required at establishment

ER promises a contribution based on actuarial assumptions, participant responsible for investments

Question 10

What are the 7 types of Profit Sharing Plans?

Answer 10

Profit Sharing Plans

Stock Bonus Plans

Employee Stock Ownership Plans (ESOP)

401K Plans aka CODA

Thrift Plans

Age-Based Profit Sharing Plans

New Comparability Plans

** Discretionary funding, must be “substantial and recurring”

Question 11

What are the basics of Permitted Disparity (Social Security Integration)?

Answer 11

Technique or method of allocating plan contributions to EE’s accounts so a higher contribution is made for EE’s w/ compensation above the Social Security wage base.

Excess method vs. Offset method

Profit sharing plans only allow the excess method be used.

Base rate (up to social security wage rate) + Excess rate

Excess rate is generally 5.7% higher than the base rate.

Base Rate + Permitted Disparity = Excess Rate, so “BP = Exxon” where Permitted Disparity equals the lesser of the Base Rate or 5.7%

Question 12

What types of entities may establish a 401K plan?

Answer 12

Corporations

Partnerships

LLCs

Proprietorships

Tax-exempt entities

Question 13

Qualified plans with CODA provisions MUST meet two additional nondiscrimination tests. What are they?

Answer 13

1. Actual Deferral Percentage (ADP) test
2. Actual Contribution Percentage (ACP) test

Safe Harbor provision eliminates the need for these annual tests

Optional nondiscrimination safe harbor for automatic enrollment plans

Question 14

How does the Actual Deferral Percentage (ADP) test work?

Answer 14

ADP for eligible HCE for the plan year is limited by the ADP for all other eligible EEs for the preceding plan year and must meet either of the following tests (see chart).

Question 15

How is Actual Deferral Percentage (ADP) calculated?

Answer 15

1. Separate the eligible EEs into HC and NHC groups.
2. Calculate the Actual elective Deferral Ratio (ADR) for each of the eligible EEs by dividing the elective deferral contribution by the EE’s compensation.
3. Once the ADR is determined for each EE, the amount of the ADP is calculated by averaging the ADRs for teh EEs within each group (HC or NHC).
4. Plug the ADP for the NHC into the chart above and calculate the maximum ADP allowed for the HC.
5. Compare the “desired/required” ADP to your actual ADP. If the HC are higher, employer failed the ADP test.

** MUST BE ABLE TO DO AT LEAST 4 & 5 ABOVE **

Question 16

What are four alternative remedies available to bring a plan into ADP or ACP test compliance?

Answer 16

Corrective distributions

Recharacterization (pre-tax to after-tax contribution)

Qualified non-elective contributions (QNEC)

Qualified matching contributions (QMC)

Question 17

What is a Corrective Distribution?

Answer 17

Used when a profit sharing plan fails the ADP test.

Easiest and usually the cheapest solution to reduce HC elective deferral by distributing or returning funds to the HCs.

Must be completed within 2.5 months after the end of the plan year. Otherwise, and 10% excise tax is imposed on the amount that should have been distributed.

Also, any earnings on the HC’s excess contributions must also be returned or distributed to the HC employees.

Question 18

What is the Actual Contribution Percentage (ACP) test?

Answer 18

Calculates a contribution percentage for both the HC and NHC for the express purpose of determining if the NHC are subject to financial discrimination.

ACP tests the sum of the EE’s after-tax contributions and employer-matching contributions.

Same calculations as the ADP test.

Same corrective measures available as the ADP test.

Question 19

What is the Safe Harbor 401K Plan?

Answer 19

Safe Harbor option:
- election can be made at least 30 days prior to close of the plan year to convert 401K plan to a non-elective 401K safe harbor status
- non-elective contribution must be at least 4% for all eligible EEs
- plan must be amended no later than the last day for distributing excess contributions for the plan year
- minimum contribution is 100% vested
- permissible contributions can either be a 3% minimum non-elective contribution or a matching contribution
- match requires 100% of the 1st 3% of EE elective deferrals and 50% EE elective deferrals greater than 3% and less than 5%

Question 20

What are features of Stock Bonus Plans?

Answer 20

participants must have:
- pass through voting rights on employer stock held by the plan
- the right to demand employer securities on plan distributions
- the right to demand ER repurchase ER’s securities if not publicly traded (the put option)
- DISTRIBUTIONS MUST BEGIN WITHIN ONE YEAR OF NORMAL RETIREMENT AGE, DEATH, OR DISABILITY, OR WITHIN 5 YEARS FOR OTHER MODES OF EMPLOYMENT TERMINATION
- DISTRIBUTIONS MUST BE FULLY PAID WITHIN 5 YEARS OF COMMENCEMENT OF DISTRIBUTIONS

Question 21

What are the differences in Stock Bonus Plans and Profit Sharing Plans?

Answer 21

Contributions: Stock vs. Cash

Valuation: Generally needed annually vs. Generally unnecessary

Portfolio Diversification: No vs. Generally yes

Voting Rights: No vs. Generally yes

Type of Distributions: Generally in stock vs. Generally in cash

Taxation of Distributions:
- Lump-sum distributions will qualify for NUA treatment. Other distributions are treated as ordinary income.
- Generally full distribution is ordinary income.

Question 22

What are the nonrecognition of capital gain treatment requirements for ESOPs?

Answer 22

ESOP must own at least 30% of the corporation’s stock immediately after the sale.

Sellers must reinvest the proceeds from the sale into qualified replacement securities within 12 months after the sale and hold such securities three years.

Qualified replacement securities are securities in a domestic corporation, including stocks, bonds, debentures, warrants, which receive no more than 25% of their income from passive investments. Can be in the form of stock in an S Corporation.

ESOP corporation must have no class of stock outstanding that is tradable on an established securities market.

Sellers, relatives of sellers, and 25% shareholders in the corporation are precluded from receiving allocations of stock acquired by the ESOP through the rollover.

ESOP may not sell the stock acquired through the rollover transaction for 3 years.

Stock sold to the ESOP must be common or convertible preferred stock and must have been owned by the seller for at least 3 years prior to the sale.