Retirement planning rules for qualified plants Flashcards
What are the age and service requirements to be eligible for a qualified plan?
- 21 and one rule
- Special provision allows up to a two-year service requirement , employee must be immediately vested (2 year/ 100% rule)
- Must work 1000 hours during the initial 12 month period after being employed will earn a year of service
- 500 hours three consecutive years will be eligible
Note: These requirements must be met one full year of service and at least 1000 hours worked during that year
An employee who meets the age and service requirement must be allowed to participate no later than the earlier of
First day of the first plan year beginning after the date, the employee first met the age and service requirement or the date six months after these conditions are met, which ever is earlier
Qualified plan coverage is further regulated through two alternative overall coverage test what are they?
Ratio percentage test:plan must cover a percentage of non-highly compensated employees that is at least 70% of the percentage of highly compensated employees who are covered if test fails then the next test must be passed
Average benefit test: average benefits for all non-highly compensated employees must be at least 70% of those for highly compensated employees
What is the minimum participation requirement for defined benefit plans?
Must benefit at least the lesser of one of the following;
- 50 employees
- The greater of 40% of all eligible employees or two employees (or if there is only one employee that employee)
Who are considered highly compensated employees? HCEs
Greater than 5% owner or an employee earning more than $155,000 in the preceding year
Who are considered key employees?
- Greater than 5%
- Officer and has compensation greater than $220,000
- Greater than 1% owner and compensation greater than $155,000
What determines a top heavy plan?
- Top heavy, if more than 60% of its aggregate accrued benefits, or account balances are allocated to key employees
- Key employees total benefits divided by the total benefits of key employees and other eligible employees
What are the Vesting schedules?
Based on date of higher (DOH)
Faster :Top heavy defined benefit plans, All defined contribution plans
- 3 year cliff or
- 2 to 6 year graded (20% a year until 100% starting from DOH) or
- 100% vested with 2 year eligibility
Slower:Non-top heavy defined benefit plans only
- 5 year cliff or
- 3 to 7 year graded (20% per year until 100% starting with DOH) or
- 100% vested with 2 year eligibility
Note: when you see the word retained in a question about keeping employees choose graded
What are the family attribution rules?
Employees who are the spouse, parent, child or grandparent of an individual who is a greater than 5% owner are also deemed to be a greater than 5% owner
What is the shorthand method for ADP / ACP testing?
0 - 2% is times 2 and 3 to 8 is plus 2
What are the two methods that a defined benefit plan can use to integrate with Social Security
Excess method and offset method
Using the excess method for a defined benefit plan using Social Security integration what is the permitted disparity?
Permitted disparity is the lesser of the base benefit percentage or 26.25%
Example:
What is the permitted disparity in a defined contribution plan using Social Security integration?
Lesser of the base contribution percentage or 5.7%
What are the steps to determine the contribution for a highly compensated employee using Social Security integration?
Step 1: calculate contribution for amount before Social Security threshold.
$168,600 x base percentage
Step 2: calculate contribution for the amount above the threshold
(Total income - $168,600) x excess contribution percentage
Step 3:
Add the results from step one and step two
In what plans can Social Security integration be used in?
- Target benefit pension plan
- Money purchase
- Profit sharing
- Stock bonus
- SEP
- Defined benefit
Note: cannot be used in an ESOP or Simple
What is a controlled group?
- Parent subsidiary: one entity owns at least 80% of one or more of the other entities
- Brother sister: five or fewer owners of two or more entities own 80% or more of each entity
- Affiliated service group: the affiliated service group rules apply primarily to service organizations that provide professional services in the field of health, law, accounting, engineering, etc.
- Employee leasing: provisions were adopted to reduce the discrimination potential from an employers choosing to lease employees from an independent employee leasing organization, rather than employ them directly
What are the deduction limits for a qualified plan section 404(c)?
Employer can deduct a maximum of 25% of all participants aggregate eligible compensation
Individual plan participants may receive contributions in excess of 25% as long as total company contributions do not exceed 25% and do not violate rules of discrimination
What is the definition of compensation?
Includes only taxable compensation paid or accrued during the tax year, includes elective deferrals under section 401(k) and section 457 and generally include salary reduction contributions to section 125 cafeteria plans
What is Keogh plan?
- Qualified retirement plan for sole proprietorship and partnerships
- May operate as defined benefit, money purchase, or profit sharing type plans
- Distinctions between self-employed and corporate plans that include the following:
- Owner employee contributions or benefit based on net earnings instead of salary. Net earned income is owner-employees net income from the business after all deductions, including the deduction for non-owner employee only plan contributions (Net Schedule C Income)
- Self-employment tax must be computed, and a deduction of 1/2 of the self-employment tax must be taken before determining the deductible contribution
What is the shortcut formula to figure out how much a self-employed individual can contribute to their qualified plan?
Take the Net schedule C income then:
Multiply by 12.12% for 15% contribution for non-owner employees or
Multiply by 18.59% for 25% contribution for non-owner employees
What is considered top heavy plans?
Define contribution plan is top heavy if more than 60% of the total amount of all employees is allocated to key employees
Plan is top heavy if more than 60% of its aggregate accrued benefits or account balances are allocated to key employees
What are the effects on contributions or benefits of top heavy plans?
Top-heavy must provide minimum benefits or contributions for non-key employees
Defined benefit (DB): must be at least 2% of compensation multiplied by the number of employees years of service in which the plan is top up to a maximum of 10 years (remember, B is the second letter of the alphabet; use 2%)
Defined contribution (DC): minimum employer contribution must be no less than 3% of each non-key employees compensation (remember: C is the third letter of the alphabet; use 3%)
What are the rules for qualified plan loans?
Can borrow from their plans on a tax-free basis, following requirements must be satisfied:
- Enforceable agreement requiring repayment
- Do not exceed the lesser of 50% of the participants vested plan benefit or $50,000. Small accounts can borrow up to $10,000 without regard to percentage limitations
- Repaid over a period not exceeding five years unless used to acquire a principal residence, does not have to be pledged as security. Another exception to the five-year loan repayment is a leave of absence less than one year.
- Long repayments are on level installments, at least quarterly. If fail to make payments according to schedule, entire balance due is deemed taxable distribution subject to ordinary income tax 10% penalty, if prior to age 59 1/2
What is the only way a non-key participant can deduct interest paid on a plan loan?
Following two conditions must be met:
- Loan is for the participants primary residence, and the loan is secured by the primary residence
Note a key employee can never deduct interest ever, even if secured by principal residence
Does a qualified plan have to provide loans?
No, it does not
How do you establish a qualified plan?
Plan document must be executed within the tax year for which the employer wishes to take the tax deduction (DB and DC) for each contribution
Safe Harbor (401k) plans must generally be adopted for the beginning of the plan year
Standard 401(k) plans with deferrals must be established before the first deferral can be made
New simple 401(k) plans may be adopted anytime on or after January 1, but not later than October 1 of the year in which it is adopted
SEP maybe established after employers’s fiscal year end. And employer has until the due date of the business tax return, excluding extensions, to establish and make contributions to a SEP for the taxable year (a note able advantage)
A defined contribution plan that holds publicly traded employers securities must allow participants to diversify employer contributions after how many years of service?
Three years
According to ERISA, can the fiduciary be sued for failing to diversify investments?
Could be yes they are required to operate a plan in accordance with the plan document
How is life insurance handled in a qualified plan?
Life insurance benefits must be merely incidental to the primary purpose of the plan, namely, to provide retirement benefits
If the amount of insurance meets either of the following test, it is considered incidental:
The aggregate premiums paid for a participants ensure death benefit are at all times less than the following percentages of the plan benefit for that participant: ordinary life, insurance and whole life 50%, term insurance 25%, universal life 25%
The participants insured death benefit must be no more than 100 times the expected monthly benefit
Define contribution plans normally use the percentage limits of 25% and 50% define benefit plan normally uses the hundred times limit (example if the monthly defined-benefit is $4000 then the life insurance death benefit can be made up to $400,000, that’s 100 times)
How do you use life insurance in a qualified plan?
Using life insurance and a qualified plan, satisfies the need for life insurance protection for the owner of a small business and provides a tax deduction to the business
If the widow receives a $40,000 lump sum life insurance benefit for her deceased husband‘s pension. The cash value of the policy is $10,000. The pure death benefit of $30,000 will be tax-free but the cash value of $10,000 will be subject to ordinary income tax
What are the only plans that are allowed to purchase life insurance?
Qualified plans
Simples and SEPs cannot have life insurance
When life insurance is purchased in a qualified plan to provide death benefits, the current cost of the pure insurance protection is subject to taxation. The cost attributable to this pure life protection will be the lower of the following.
Actual cost as provided by the carrier and table 2001
Which plans can hold a second to die insurance policy
Only profit-sharing plans can hold a second to die insurance policy pension plans cannot
Can qualified plans, hold disability insurance?
Yes
