Retirement Planning - Pension Plans and Profit sharing Plans Flashcards
What are traditional pension plans?
Traditional pension plan pays a formula determined benefit beginning at retirement, usually in the form of an annuity, to a plan participant for the participants remaining life.
Pension Plans have a legal promise to pay a pension.
What are the 4 types of Pension Plans?
2 Defined Benefit Plans:
Cash Balance pension plan
Defined Benefit Pension Plan
2 defined contribution plans:
money purchase pension plans
target benefit pension plans
What is the common calculation for Defined Benefit Plan Contributions?
Annual Pension Benefit Amount = % of years of service x Number of years of service x Average of the 3 highest consecutive years of salary
Are Defined Benefit Plans and Defined Contribution Plans subject to mandatory Funding?
Yes.
Do Pension Plans allow for in-service withdrawals?
No.
however, defined benefit pension plans can provide in-service distributions to participants who are age 62 or older.
What is the limit on investing in employer securities for pension plans?
-Aggregate value of the employer securities cannot exceed 10% of the fair market value of the pension plan assets at the time the employer securities are purchased.
What are the rules surrounding life insurance in qualified plans?
For a qualified plan that holds life insurance to maintain its qualified status, it must meet either the 25 percent test or the 100 -to-1 ratio test.
25 percent test:
- if term insurance or universal life policy is purchased within the qualified plan, the aggregate premiums paid for the life insurance policy cannot exceed 25 percent of the employers aggregate contributions to the participants account.
- whole policy = aggregate premiums paid for the whole life insurance policy cannot exceed 50 percent of the employers aggregate contributions to the participants account.
100-to-1 Ratio Test:
-limits the amount of the death benefit of a life insurance coverage purchased to 100 times the monthly accrued retirement benefit provided under the qualified plans defined benefit formula.
Actuary for Defined Benefit Pension Plans vs. Defined Contribution Pension Plans?
Actuary:
Defined Benefit - annual actuarial services, can drive up cost
Defined contribution - Target benefit plan, only at the inception of the plan. Money purchase plan no need for for actuarial services.
:
How does the Pension Benefit Guaranty Corporation insurance (PBGC) work?
- Owners of Defined benefit pension plans pay premiums for insurance coverage designed to pay the promised pension in the event plan is underfunded or unfunded.
- Does NOT Insure defined contribution pension or profit sharing plans. or Defined benefit pension plans of professional service corporations with 25 or fewer participants.
- only pays a limited retirement benefit - $74,454 per year or $6,204 per month.
what is the accrued benefit?
Defined benefit pension plan - Employee who terminates participation in the plan, will be entitled to benefit payable from the plan equal to the retirement benefit earned to date. This is actuarial equivilant of benefit that would have been provided had the participant waited until retirement to receive benefits.
Defined Contribution Pension Plan - accrued benefit is equal to the account balance of the qualified plan consisting of any combination of employer and employee contributions plus earning minus unvested amounts.
What is the credit for prior service?
- Only applies to defined benefit pension plans.
- An employer who establishes a DB plan may elect to give employees credit for their services prior to establishment of the plan.
- Must be non-discriminatory and generally benefits an older owner-employee
What is permitted disparity (social security integration)?
- all qualified pension plans may use
- allows a higher contribution or allocation of benefits to employees whose compensation exceeds the social security wage base for the plan year.
- Two methods the excess method and the offset method.
Defined benefit plans can use either method
Defined contribution plans can only use the excess method.
Permitted disparity - Excess Method
- both DB and DC pension plans can use.
- provides an increased benefit percentage benefit (excess benefit) to plan participants whose earnings are in excess of an average of the social security wage base. Called covered compensation limit.
– Only applies to income that exceeds the covered compensation limit and is limited to the lesser of:
- .75% per year of service, or
- the benefit percentage for earnings below the covered compensation limit per year of service.
maximum increase in benefits for compensation over the ocvered compensation limit is 26.25% (.75% x 35 years)
Permitted disparity - offset method
- applies a benefit formula to all earnings and then reduces the benefit on earnings below the covered compensation limit.
- reduction of benefits limited to lesser of:
1. .75% per year of service up to 35 years
2. 50% of the overall benefit funding percentage per year of service.
As with the excess method, the total reduction is limited to 26.25% of the earnings below the 35 year covered compensation limit.
Defined Benefit pension plans vs. Defined Contribution pension plans chart.
What are the formulas for calculating Defined benefit pension plan payouts?
What are the key features of Cash Balance Pension Plans?
-Benefit, which is a guaranteed return and is determined under the plan document, will be payable to the participant at retirement regardless of the plan’s true earnings, wether greater or less than the benefit provided by the formula.
Example: 5% pay credit with a guaranteed interest credit of 2% = 5% of salary is contributed and the balance earns a guaranteed 2% rate of return.
- Does not have separate account. Funds commingled in one account that has a value equal to the actuarial equivilant of the present value of expected future benefits.
- More beneficial for younger participants, they have more years of contributions and earnings.
- 3 year cliff vesting.
What is a cash balance plan conversion?
- cash balance plan conversion occurs when an employer changes from a traditional DB plan to a cash balance plan.
- hybrid plan must meet three requirements:
1. a participants accrued benefit, as determined as of any date under the date of the plan, would be equal to or greater than that of any similarly situated younger participant. someone is similar situated to a participant if the individual and the participant are identical in every respect, except for age.
2. interest rate used to determine the interest credit on the account balance in the hybrid plan must not be greater than the market rate of return.
3. for plans beginning after 2007, the hybrid plan must provide 100 percent vesting after three years of service.
What are the key features of a money purchase pension plan?
- defined contribution pension plan that provides for a contribution to the plan each year of a fixed percentage of the employees compensation.
- employer is not required to guarantee a specific retirement benefit.
- employer cannot deduct contributions to plans in excess of 25 percent of employers total covered compensation.
- contribution limited to lesser of 100 percent of compensation or $61,000
- contribution to a separate account on behalf of each participant.
- benefit younger participants, more contributions and earnings.
- subject to all of the eligibility, coverage, and vesting rules applicable to defined contribution pension plans.
What are the key features of Target Benefit Pension Plans?
- determines the contribution to the participants account based on the benefit that will be paid from the plan at the participants retirement.
- contribution to each participant during the plan year that is actuarially equivalent to the present value of the benefit at the participants retirement.
- Actuary required at beginning of formation of the plan, but not annually.
- Employer promises a contribution to the participants account based on the original actuarial assumptions.
- once contribution has been made, participant is responsible for investments, participant is entitled to plan balance regardless of its value, be it greater or less than target benefit.
- People are using age weighted profit sharing plans instead of these types of plans.
What are the 7 types of profit sharing plans?
profit sharing plans stock bonus plans employee stock ownership plans 401k plans aka CODA Thrift Plans Age-Based Profit Sharing plans New Comparability Plans
How are Profit Sharing Plan Funds Allocated?
- Profit sharing plans must provide a predetermined formula for allocating plan contributions to employees accounts.
- standard method of allocating contributions to a profit sharing plan is simply to allocate contribution based on a percentage of each employees compensation.
Permitted Disparity - Profit Sharing Plans.
- Profit sharing plans can only use the excess contribution method.
- two contributions rates established, base rate and excess contribution rate.
base rate is applied on earned income up to the integration level (social security wage base)
excess rate is applied to income earned above the integration level but only up to maximum covered compensation limit for the year of $305,000.
-permitted disparity = lesser of base rate or 5.7%
*****Excess rate is generally 5.7% higher than the base rate
Base Rate + Permitted Disparity = Excess Rate
BP=Exxon
Roth IRA’s vs. Roth 401ks
How about employer contributions for 401k plans?
Employee elective deferral contributions do not count against the plan contribution limits of 25 percent, so employer can make contributions.
Both the employee and employer contributions cannot exceed a total of $61,000.
The catch up is still allowed for a total of $67,500 over age 50.
What is the ADP Testing?
- see chart for Schedule, MEMORIZE!!!
- can use prior year NHC ADP to calculate maximum Deferral for HC individuals or Current Year NHC ADP to calculate maximum deferral for HC individuals.
What happens when you fail the ADP or ACP test?
-Puts plan at risk for disqualification.
Employer has 4 options to correct the plan:
- Corrective distributions
- Re-Characterization
- qualified non-elective contributions (QNEC), or
- Qualified matching contributions (QMC)
What are Qualified Non-Elective Contributions (QNEC) for ADP Test Failure?
- Employers can make a qualified non-elective contribution (QNEC) to all eligible NHC employees CODA accounts to increase the ADP of the NHC employees to pass the test.
- Made to all eligible NHC employees covered by the plan.
- Treated as an EMPLOYEE elective deferral and therefore is 100% vested!
What is the Qualified Matching Contributions (QMC) for ADP Test Failure?
- Similar to a QNEC, however it is only made to those eligible who participated in the plan during the year.
- Treated as an EMPLOYEE elective deferral and is 100% vested.
What are the rules surrounding Qualified plan loans?
- See photo for all of the rules.
- Must be repaid within 5 years.
- if you fail to repay the loan in accordance to the plan term, loan will be treated as a distribution as of the date of the original loan. subject to penalties
- most plan documents require that loans be repaid upon termination of employment; however some have exceptions and grace peeriods.
- loan balance may also be deducted from Rollover balance
Stock Bonus Plans vs. Profit Sharing Plans
Distributions from Stock Ownership Plans?
- Cash Distributed, no deferall of income tax on the stocks appreciated value (NUA Benefit)
- Distributions of Stock:
Lump Sum - Employee is subject to ordinary income tax in the year of the distribution based on the securities fair market value at the time of the contribution
NUA is not taxed at the time of the distribution but is a long term capital gain until the stock is sold.
Installment distribution - NUA is only available for appreciation of stock purchased with after-tax contributions
What is an Employee Stock Ownership Plan?
- An ESOP Is controlled through a trust, the sponsor company receives tax deductions for contributions of stock from the corporation.
- The trust may borrow money from a bank or other lender to purchase the employer stock. The corporation generally repays the loan through tax-deductible contributions to the to the ESOP
- Both interest and principal payments for the loan are income tax deductible.
- ESOP must satisfy all applicable rules of qualified plans (vesting, participation, eligibility, and coverage).
- Image is of a Leveraged ESOP Transaction
What are the advantages & disadvantages to the of an ESOP?
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