Retirement Plans Flashcards
0
Q
Qualified Plans are either….
A
- Pension Plans
2. Profit Sharing Plans
1
Q
Advantages of Qualified Plans not available to Nonqualified Plans
A
- ER contributions deductible by ER in the year contributions are made
- ER contributions not subject to payroll tax
- Protected from creditors by ERISA
2
Q
Pension Plans Characteristics
A
- ER’s promise to pay a benefit or make a contribution
- Mandatory Annual Funding
- In-service w/d’s from “CERTAIN” pension plans EE’s 62+
3
Q
Types of Pension Plans
A
- Traditional Defined Benefit Plan
- Fully Insured Defined Benefit Pension Plan - Section 412e - Cash Balance Pension Plan
- Money Purchase Pension Plan
- New Comparability Money Purchase Pension Plan - Target Benefit Pension Plan
- DBk Plan (Hybrid)
4
Q
Profit Sharing Plan Characteristics
A
- Promise to defer taxes
- In-service w/d’s allowed if document permits
- Substantial & Recurring ER contributions, Not Mandatory.
5
Q
Define Benefit Pension Plan
A
- ER wants to contribute to the maximum extent to benefit older EE’s.
- Older controlling EE’s in small business want to maximize tax deferral retirement for key employees.
- ER needs stable cash flow.
6
Q
Defined Benefit Plan Disadvantages
A
- Actuarial and PBGC result in higher costs
- Complex
- Mandatory funding
- ER assumes risk
7
Q
Defined Benefit Pension Plan Advantages
A
- Retirement benefits at adequate levels provided to all EE’s regardless of age at plan entry
- Benefit levels guarranted
- For older, highly compensated EE’s
8
Q
DBk Plan is a Hybrid Plan (Defined Benefit Plan)
*Address shortfalls of 401k plan
A
- Guaranteed monthly income at retirement; No more than 500 EE’s
- Automatic enrollment and fully vested 50% match on first 4% compensation deferred by EE.
- Combines the security EE’s get through traditional defined benefit plans with individual investment control.
- Exemption from top heavy rules
- Simplified adm. and potentially lower cost
9
Q
Cash Balance Pension Plan
A
- Type of defined benefit plan with features similar to a defined contribution plan.
- ER contributions at specified rate to hypothetical individual accounts maintained for each participant.
- ER guarantees both a contribution level and a minimum rate of return.
- Cash Balance Plan similar to Money Purchase Plan but has ER Guaranteed Rate of Return.
- Must use 3 Year Cliff Vesting
10
Q
Cash Balance Pension Plan is appropriate when…
A
- EE group is relatively young
- EE’s want security of retirement income
- Large work force and EE’s middle income wage earners
- ER able to spread adm cost over large group of participants.
11
Q
Cash Balance Pension Plan Advantages
A
- Distributions may be eligible for special 10 year forward averaging
- ER guarantee of return removes investment risk from EE
- Benefits guaranteed by the PGBC
- Benefit methods flexible
a. ER’s may provide same benefit to all EE’s, as in the case of a fixed % of compensation
b. Contribution %’s can be higher for EE’s with longer service
12
Q
Cash Balance Pension Plan Disadvantages
A
- Retirement benefits may be to low for older EE’s.
2. Plan is more complex administratively than a defined contribution plan
13
Q
Fully Insured Defined Benefit Plan
A
- Fully insured person plan is a type of traditional defined benefit pension plan funded exclusively by the cash value life insurance or annuity contracts under Tax Code Section 412e
- No qualified plan trust exits
- Exempt from minimum funding
- No actuary
- For ER who cannot commit to regular premium payments
14
Q
Money Purchase Pension Plan
Defined Contribution Plan
A
- ER mandatory contributions to each EE’s account under a non discriminatory contribution formula (either fixed % or flat dollar amount).
- ER contribution limited to the lesser of 100% compensation or $51,000.
3 ER contributions limited to 25% of total covered compensation paid to EE’s.
15
Q
Money Purchase Pension Plans (Advantages)
A
- Simple and inexpensive to design, adm, and explain
- No actuary services
- No PBGC insurance, not required
- Favor Younger EE’s.
- MPPP limit ability to use the plan contributions to finance the company. (MAX 10% COMPANY STOCK permitted in the plan)
- EE’s may make after tax contributions to the plan
16
Q
Money Purchase Pension Plans Disadvantages
A
- Retirement benefits uncertain
- EE’s bear the risk
- No w/d’s before separation of service
- Loans allowed but rare
- Plan subject to Erisa
17
Q
Target Benefit Plan
A
- ER choose target level of retirement benefits as a % of annual compensation
- Requires an actuary when plan is implemented but not needed annually
- EE bears risk
- EE has individual account
- Actual dollar amount not guaranteed.
- Favor older EE’s
18
Q
50/40 Test
Additional coverage for DB Plans
A
- All defined benefit plans require coverage on each day of the plan year for the lesser of: 50 EE’s or 40% or more of all eligible (nonexcludable) EE’s.
- For purposes of the 40% test, the plan does not have to consider EE’s who are not eligible for the plan. Noneligible EE’s include the following:
- EE’s who do not meet the age & service requirements
- Excluded EE’s, Union workers and Nonresident alines
19
Q
Minimum Funding - Top Heavy plan must provide non-key ee’s with minimum benefits or contributions
A
- DB - 2% times number of years of service up to 20%
2. DC Plans - 3% of total compensation
20
Q
ADP Testing “Actual Deferral Percentage Test”
401k Plans
A
If ADP for NHC: Maximum ADP for HC is:
< 2% 2 x ADP of NHC
> 2%, but < 8% 2% + ADP of NHC
> 8% 1.25 x ADP of NHC
21
Q
Annual Contribution Percentage Test
ACP
All Qualified Defined Contribution Plans
A
ACP = Actual contributions divided by EE Compensation
- ACP for highly compensated EE’s cannot be more than 1.25 times the ACP for nonhighly compensated EE’s.
- The average ACP for highly compensated EE’s must not be more than twice the ACP for other EE’s and must not exceed the ACP for other EE’s by more than 2%.
22
Q
ACP Ratios
A
If ACP for NHC: Maximum for ACP for HC is:
< 2% 2 x ACP of NHC
> 2%, but < 8% 2% + ACP of NHC
> 8% 1.25 x ACP of NHC
23
Q
Safe Harbor Rule
Alternative method of meeting non discrimination testing
A
- Safe Harbor ER contributions must be 100% immediate Vested
- Matching contributions for NHC EE’s
- 100% match up to 3% of compensation plus 50% match for contributions between 3% & 5%. The matching contribution %’s of the HC EE’s cannot exceed those of the NHC EE’s.
- Nonelective contributions - ER may make contributions of 3% or more of compensation for all NHC EE’s who are eligible to participate in the plan, regardless if EE choose to participate or note.
24
Defined Benefit Paid out cannot exceed the lesser of:
1. 100% of compensation averaged over the 3 highest consecutive years of compensation or,
2. $205,000 as indexed for inflation
25
Defined Contribution Plan
1. Annual additions limit for all defined contribution plans sponsored by one ER cannot exceed the lesser of:
a. 100% of the participant's annual compensation, or
b. $51,000
26
Defined Benefit Plan: Promise to pay a specific benefit at retirement. Appropriate when...
1. Primary plan objectives is to maximize plan contributions for Older EE's and Owner
2. Company is established and has stable cash flow
27
Defined Benefit Plans Advantages
1. Tax deferred savings
2. Retirement benefits can be provided regardless of age
3. Benefit levels guaranteed
4. For older, highly compensated, allows maximum amount of tax deferred retirement savings
5. May encourage early retirement.
28
Pension Benefit Guaranty Corporation (PBGC)
1. Defined benefit plans subject to mandatory PBGC coverage
2. Maximum guaranteed benefits if $4,789.77 per month or $57,477.24/year.
3. Benefit payments by the PBGC financed by premiums paid by sponsors of DB plans
29
DB Flat Amount Formula
1. Does not differentiate among EE's with different compensation
2. May required some minimum service 15 -20 years.
Example: $1000/month for life beginning at age 65.
30
DB Unit Benefit (Unit Credit) Formula
1. Known as "percentage of earnings per year of service' formula
2. Use both average earnings and years of service to calculate retirement benefit
Example: 1% per year of service
31
SIMPLE 401k
1. 100 EE's or less who earned at least $5,000 during the year and do not maintain another ER Retirement plan (2 year grace period to maintain plan when EE's > 100)
2. Self Employed person can participate
3. Only other plan ER can maintain is a 457 with a Simple.
4. No ADP testing and not Top Heavy Rules
32
SIMPLE 401k Contributions
1. EE deferrals limited to $12k
2. ER match EE deferrals up to 3% of compensation, or alternatively makes 2% of compensation nonelective contribution on behalf of all EE's.
a. ER contributions 100% vested
b. ER cannot reduce matching % below 3% (Unlike Simple IRA)
c. ER's may allow EE's catchup of $2,500
33
KEOGH (Self Employed Plan)
Types of Entities that have Keogh Plans include
Proprietorships
Partnerships
LLPs
LLC's taxed as proprietorships or partnerships
34
Keogh plan usually designed as one of the following
1. Profit sharing
2. Money purchase
3. Target benefit plan
35
KEOGH Plans or HR - 10 Plan
1. A qualified retirement plan that covers one or more Self employed individuals
2. Two primary differences between a KEOGH and other Qualified Plans.
First, Self Employed calculate their retirement plan contribution based on net earned income instead of W-2 Income
Second, Self Employed must use a net contribution rate in determining their allowable contribution to a Keogh defined contribution plan.
36
S Corporations do not have self employed owners and therefore do not have a
Keogh plan. Their contributions are based on W-2 Earnings.
37
SIMPLE Plans Do Not Favor...
Older Participants. In additional SIMPLE plans provide for 100% Immediate vesting of ER contributions.
38
Target Benefit Plan
1. Money Purpose Pension Plan/ Defined Contribution
2. Age Weighted & favors Older EE's
3. Actuary needed at beginning
4. ER chooses a retirement target % of annual compensation
5. EE bears risk
6. Actual dollar benefit not guarantee
7. Participants have individual accounts
39
Money Purchase Pension Plan
1. Pension Plan/Define Contribution
2 ER makes mandatory $$
3. ER's contribution is a Fixed % between 0-25% EE wages
4. Used to retain Key EE's and when EE's are young with higher incomes
5. Easy Administration
40
Profit Sharing Plan
1. Profit Sharing/Defined Contribution
2. Funding Flexible
3. Used to attract and retain EE's
4. Contributions may be made with company stock
5. Can be integrated with SS
41
Stock Bonus Plan
1. Profit Sharing/Defined Contribution
2. Deduction for noncash contribution
3. EE's can vote stock in nplan
4. Distributions generally in stock
5. Valuation issues and cost
42
ESOP (S Corporations can Establish)
1. Stock Bonus
2. ER can sell stock to plan - No Tax
3. Leverage
4. Age 55/10 years participation - diversification
5. Put option
6. No integration
43
Section 401k Plan
1. CODA: CODA does not count against 25% limit.
* May be over $51k if catch up is available
2. ADP/ACP vs Safe harbor Plans
3. Limits
a. $17,500 plus catch up
b. 100%/$51,000
c. ADP
44
Max Contribution to Defined Contribution Plans by EE's
1. $17,500
| 2. Catch up: $5,500
45
Max Contribution to Define Contribution Plans EE & ER
1. ER deduction:
25% Limit
1. Profit Sharing
2. Match
3. QNEC/QMC
} combined Total Limit
2. EE: lesser of 100% or
$17,500 $51,000
$5,500
46
Profit Sharing Plans
1. No Promised Benefit or Contribution.
2. Only promises to tax deferral
3. Substantial and Recurring Contributions
4. Inservice withdrawals permitted
47
Qualified Plans - Rules and Advantages
1. ER contributions are tax deductible
2. EE contributions not currently taxed (except: Thrift/Roth 401k after tax $$)
3. Earnings tax deferred
4. DOB prior to 1/2/1936
10 year forward averaging
Capital gains pre-1974
5. NUA on ER stock
6. Creditor protection (ERISA)
48
Net Unrealized Appreciation (NUA)
1. Includes ER Securities
- Stock
- Bonds
- Parent company/subsidiary securities
2. No Minimum participation required
49
Protection for Creditors
1. ERISA
- Unlimited Protection from Creditors
- Qualified plans (multiple participants)
2. Non ERISA laws and rulings
- Unlimited Protection
- All Qualified Plans
- Rollover IRA's
- SEP IRA's and SIMPLE IRA's
3. First $1 Million protected in the event of bankruptcy
- Traditional and Roth IRA's
50
Qualified vs Nonqualified Plans
Qualified Plans Nonqualified Plans
Establishment Dec 31st Anytime
Funding Date of Return Anytime
(including extensions)
Current Tax Benefits ER deduction & EE deferral only
EE deferral
ERISA Yes No
Discrimination Testing & Yes No
Other Testing
Flexible Limited Yes
*Pension plans must be funded by Sept 15
51
Defined Benefit vs Contribution Plans
Defined Benefit Defined Contribution
Investment risk ER EE
Funds Commingle Separate accounts
PBGC Yes* No
Public service credit Yes No
Annual limits $205,000 Lesser of 100% wages
(benefit) or $51k (annual
additions
Who benefits Older Younger
Easy to communicate No yes
*Exception to professional service firms with 25 or fewer EE's
52
Pension Plans vs Profit Sharing Plans
Pension Plan Profit Sharing Plan
Legal Promise Pay Pension Defer Tax
In-service w/d's 62+* Permitted after 2 yrs
Mandatory Funding Yes No**
Plan investment in ER 10% 100%
Securities Limit
ER plan contribution 25% or more*** 25%
limit
*as per pension protection act of 2006
**must be substantial and recurring
***"or more": defined benefit plans able to have higher contributions
if required actuarially (for older ee's)
53
Qualified Plans Establishment
```
By Dec 31
In writing
IRS determination Letter
Communicated to EE's
Permanent
No prohibited transactions
```
54
Highly Compensated EE
Greater than 5% owner in current or preceding year
OR
Compensation > $115,000 in preceding year
**IF ER elects, only those in Top 20% of compensation (Top 20% does not Remove HCE with > 5% ownership)
*Family Ownership Attribution Rules
55
Key EE
***ALWAYS an OFFICER or OWNER!!!
```
Officer with compensation > $165,000
OR
> 5% Owner
OR
>1% Owner with Compensation > $150,000
```
56
Coverage Tests for Qualified Plans
1. General Test #NHC covered / #NHC EE's eligible > 70%
2. Ratio Test: %NHC / %HC EE's covered > 70%
3. Average Benefits Percentage Test
Benefits received by NCH / NHC Compensation
DIVIDED > 70%
Benefits received by HC / HC Compensation
57
Qualified Plan Coverage Test
ER has 200 nonexcludable EE's, and 10 are Highly Compensated (HC). Nine of the HC and 120 of the 190 nonhighly compensated (NHC) benefit from the plan. The average benefit for the HC is 8%, and the average benefit for the NHC is 6%
General Test: 120 / 190 = 63% (Fail)
Ratio Test: 120/190 divided by 9/10 = 70% (Pass)
Average benefits percentage test: 6% / 8% = 75% (Pass)
58
Application of Coverage Tests
1. Excluded EE;s
a. Salary vs hourly
b. Geographic location
c. Union vs non-union
2. EE is considered covered if:
a. EE is benefiting under plan
b. 401k Plans - EE is eligible to defer! Can the EE defer? If they are eligible to defer then then are considered covered.
59
Attribution Rules
1. Ann individual is considered owning the stock owned, directly, or indirectly by or for:
a. Spouse
b. Children
c. Granchildren
d. Parents
* Also applies to ownership through estates, partnerships, trusts, and so on
* *Attribution rules apply to highly compensated and key employee definitions.
60
The 50/40 Test
1. One each day of plan year, Defined Benefit Plans must cover lesser of:
A. 50% EE's
B. 40% of Eligible EE's
*If five or fewer eligible EE's, two must be covered.
2. Noneligible EE's:
a. Do not meet age and service requirements
b. Nonresident aliens
c. Union Members
61
TOP Heavy Plans
1. >60% accrued benefits or contributions to key EE's
2. Accelerated Vesting Requirements
3. Minimum during for non-key ee's
a. DB - 2% comp. x years of service (up to 20%)
b. DC - 3% comp.
62
Define contribution Plan Tests
1. Actual Deferral Percentage Test ADP = Actual deferrals divided by EE compensation
Both Voluntary Pre-tax and Voluntary after-tax Roth 401k
2. Section 401k Plans
63
ADP Tests
Test 1 - the ADP of eligible highly compensated EE;s (HCE) must not be more than the ADP of all other eligible EE's (NHC) multiplied by 1.25
Test 2 - the ADP for eligible highly compensated EE's must not exceed the ADP for other eligible EE's by more than 2%
The ADP for eligible highly compensated EE's must not be more than the ADP of all other eligible EE's multiplied by 2
64
Defined Contribution Plan Tests (ACP)
1. Actual Contribution Percentage Test (ACP)
a. All qualified DC plans
b. Contributions include:
- ER matching
- Mandatory EE
- Voluntary after tax EE
- Excludes Roth 401k deferrals
c. ACP = Actual Contributions Divided by EE compensation
65
ADP and ACP Test Failure
1. Corrective distribution - HCE now refunded assets back because of failure with the test. HCE's get a refund back from the money they had invested into the retirement plan, decreasing their retirement income, and increasing their income and their taxes for that year.
2. Qualified Non-Elective Contribution - the ER makes an extra contribution to all EE's , (puts in say 3% for all ee's), and it increases the NHC contributions for the year.
3. Qualified Matching Contribution...the ER does it as a match. Not across the board for all EE's, only those who are already participating in the plan presently.
66
Other Limitations and Tests
1. Compensation Limit = $255,000 for 2013
2. Defined Benefit Plan
a. Benefit at age 62 or SS NRA, if later, cannot exceed lesser or:
- 100% of EE's compensation average over 3 highest years
- $205,000 (2013)
67
Other Limitations and Tests
1. Defined Contribution Plans
a. Annual Additions (415 limit) limited to:
- 100% of EE's contribution
- $51,000
2. Annual additions include
a. ER contributions
b. EE contributions (NOT rollovers)
c. Forfeitures Reallocated to Participants
68
The Covered Compensation limit for 2013 is
$255,000.
Therefore no more than $255,000 can be considered for purposes of qualified plans
69
Money Purchase Pension Plan
1. Qualified Pension Plan
2. ER mandatory contributions
3. Max plan investment of 10% of company
4. Integrated with SS
5. Fixed percentage formula
6. Favors Younger Plan Participants
70
Money Purchase Pension Plan
1. ER makes annual mandatory contributions to each EE's account under a nondiscriminatory contribution formula
2. Only the first $255,000 of each EE's compensation may be taken into account.
71
Profit Sharing Plans Application
1. ER's $$ varies
2. ER wants qualified plan with incentive
3. EE's relatively young
4. EE's bear risk
5. ER wants to supplement existing defined benefit plan
72
Stock Bonus and ESOP Disadvantages
1. Non diversified portfolio
2. Appraisal costs
3. Dilution of ownership
73
Stock Bonus Plan vs ESOP
ESOP may borrow funds to purchase stock
74
Net Unrealized Appreciation NUA
1. Ordinary Tax on basis of stock, received from ER
2. Lump Sum distribution Ordinary stock on tax value of the stock that was first given to the EE from ER
3. All growth after that point is LTCG
75
Stock Bonus and ESOP's
These plans, are qualified plans...and are subject to discrimination requirements.
76
Stock Bonus and ESOP
At distribution, Participants recognize ordinary income equal to the sum of the deductions the ER took at the time of contributions.
77
401k Plans
1. Qualified profit sharing or stock bonus plans
2. EE's defer contributions or receive cash. EE's receive compensation each year, and EE can choose not to receive all of their compensation and defer the $$ into the plan...and taxed later.
3. Pre-tax or after tax contribution.
78
401k Appropriate
1. ER wants qualified plan with minimal cots
2. EE wants funding by elective deferrals
3. Wants supplement to existing retirement plan
3. EE's want a choice in savings
4. EE's are young with time to accumulate savings
5. EE's willing to accept risk.
79
401k Disadvantages
1. Retirement account may not be adequate
2. Max elective deferral $17,500 with $5,500 catch up for 50+
3. ER deduction max 25% total covered participant compensation
4. Additional nondiscrimination tests: ACP and ADP
80
401k Plans (CODA's) Elective Deferrals
1. Partial or total funding by EE elective deferrals
2. Elective deferrals/earnings 100% vested
3. Participants in multiple plans must aggregate elective deferrals in applying annual limits (exception Sec 457 plans)
81
Roth 401K Plans
1. Used with Traditional 401k
2. After tax free qualified distributions
3. ER qualifications made to regular 401k account
4. Roth 401k balances tracked separately
82
Roth 401k Plans Contributions
1. Max deferral $17,500
2. Age 50+ $5,500 catch up
3. Contributions in after-tax dollars
4. No phaseout based on AGI
5. Deferrals included in ADP calculation
83
Section 401k Plans must satisfy both the...
ADP and ACP tests
84
A Section 401k statements are correct
1. Can be funded entirely through elective deferrals
| 2. Must satisfy the Safe Harbor Coverage Test, the Ratio Percentage Test, or the Average Benefits Test.
85
A Section 403b plan is a tax-advantaged plan but not a
qualified plan
86
Qualified plan rules provide greater flexibility in the number and makeup of the EE's covered by the plan the do the rules pertaining to
SEP and SIMPLE Plans
87
IRS Form 5500
1. Required to be filed by all ER's with 100 plan participants
2. Is known as the ER's annual return/report of an EE benefit plan
3. Schedule A must be filled if any benefits are provided by insurance
88
The Summary Plan Description
1. Musts indicate any situation that could result in a participant losing benefits
2. must describe and explain the plan's vesting schedule
3. need not be filed with the DOL
89
All Plans are allowed to integrate with SS except for:
ESOPs, SIMPLE, SARSEPs.
**The excess method is allowed for all plans allowing integration, whereas the offset method is only allowed for defined benefit plans.
90
The exception to the 21 and 1 rule is the....
2 year/100% rule that allows up to a 2 year service requirement if the EE is immediately 100% vested in ER contributions upon becoming a participant
91
The IRS carries out the adm of qualified plan system by...
1. Supervising the creation of new retirement plans and monitoring and auditing the operation of existing plans
2. Interpreting federal legislation, especially with regard to the tax consequences of certain pension plan designs
3. Administering the qualified plan system
92
Safe Harbor Plans are not required to comply with...
ADP, ACP or Top Heavy Rules.
***ALL PLANS must Meet the General Coverage Nondiscrimination Rules under Section 410
93
A Target benefit plan is a defined contribution plan that initially projects an....
actuarially targeted retirement benefit, however, no subsequent adjustments are made in later years, so there is no guarantee of achieving that benefit.
94
A person is an active participant in any type of defined contribution plan if...
any addition contribution for the participant is made for the year.
95
Generally, a person is an active participant in a define benefit plan unless...
excluded under the eligibility provision for the entire year. f
96
On Jan 15, Derek, age 40, withdrew 50k from his trad. ira. The balance in the IRA was $500,000 before the distribution. Derek made contributions to his IRA of 30k/year over 18 years of which 10k was deductible. What is the amount of any early distribution penalty?
Before determining the early w/d penalty, the taxable portion of the distribution must be determined. Derek made 20k of after tax contributions to the traditional IRA, calculated as follows:
1. Total contributions to IRA $30,000
Deductible contributions -10,000
After-tax contributions (basis) $20,000
After tax contributions into a traditional IRA are recovered pro rate when a distribution occurs. Because Derek distributed 10% of his IRA balance (50k distribution divided by $500,000), 10% of the basis is recovered.
Distribution from IRA $50,000
Basis recovery ($20,000 x 10%) -$2,000
Taxable portion of distribution $48,000
The early distribution penalty is $4,800 ($48,000 x 10%)
97
Worker's who delay applying for retirement benefits until after full retirement age are eligible for an
increased benefit of up to 8%
98
Defined benefit plans usually provide more retirement income than...
Defined Contribution plans because defined benefit plans can fund for the past service.
99
A Phantom Stock Plan includes
1. Is a type of unfunded deferred compensation plan
2. Benefits will be paid in cash
3. Is based on the value and transactions of an imaginary stock which mirrors the value and transaction of the ER's stock
4. Has an exercise date that it is controlled by the ER
100
Section 403b do not permit....
10 year forward averaging.
101
Tax sheltered TSA Plan
1. The plan is a salary reduction plan
2. The plan permits investing in mutual funds holding shares of gold mining stock
3. The investment risk is borne by the EE's
4. The plan may permit in service withdrawals
102
Which plan is a hybrid retirement plan that uses a benefit formula like that of a defined benefit plan and individual accounts like that of a defined contribution plan?
1. Target Benefit Plan
The plan described is a target benefit plan. The contribution is derived from the benefit formula in a target benefit plan, but once determined, the plan resembles a money purchase plan in all other ways.
103
For Simple IRA, an ER is required to satisfy one of two contribution formulas:
1. Match dollar for dollar EE contributions up to 3% of EE's income, or
2. Contribute at least a 2% nonelective contribution for each eligible EE
104
A client's objectives are to adopt a plan that has predictable costs, is administratively convenient, and is easily communicated to EE's. Which plan represents the best choice?
Answer: Money Purchase Pension Plan.
105
A defined benefit plan maintained by a professional service ER with 25 or fewer EE's does not need to be covered by ...
the PBGC!
117
Defined Contribution Plans Integration with SS
Based Percentage Maximum permitted Excess %
(A) Disparity (B) (A) + (B)
1% 1% 2%
3% 3% 6%
5% 5% 10%
6% 5.7% 11.7%
10% 5.7% 15.7%
15% 5.7% 20.7%
118
SS Integration Level with Qualified Plans
1. Generally, the integration level is equal to the SS taxable wage base which is $113,700.
2. The integration can be lower than the SS tax wage base, which allows more income to be considered for excess contribution level.
a. As the integration level is lowered so it the maximum permitted disparity between the based percentage and the excess percentage.
b. Generally, the integration level will be set on the basis of the EE census.
119
Plans that cannot Integrate with SS
1. ESOPs, SIMPLEs, SARSEP plans are not permitted to integrate with SS.
2. EE Elective Deferrals and ER matching contributions to Section 401k plans cannot be integrated with SS
3. Profit-Sharing ER contribution by ER to Section 401k plan can be integrated.
120
SEP Description
"Other Tax Advantage Plan"
"Alternative to Qualified Plan"
1. EE cannot contribute
2. ER is the only one who contributes
3. Lesser of 25% of EE compensation or $51,000.
4. 100% Immediate Vested
5. All EE's who...
a. AT least 21 yrs old
b. Worked for ER 3 out of 5 years (includes Part time)
c. Compensation of >$550
d. May exclude union EE's
121
SEP Applications
1. CAN be established by tax return filing date (similar to person making an IRA contribution for previous year on April 15)
2. Allocation Options
a. Pro-rata based compensation
b. Flat dollar amount
3. ER can establish for previous year as long as it happens by tax filing date
3. SS Integration
122
Income for IRA
1. Income includes:
- Wages & Salary
- Tips, bonuses, fees
- Alimony
- Separate - maintenance income
2. Excludes
- Earnings and profits from property
- Pension, annuity income or unemployment
- Deferred compensation received
- Excluded foreign earned income/housing cost
123
IRA Participation Rules
1. IRA deduction may be phased out if taxpayer/spouse is active participant in qualified plan
a. Includes SEPs. SIMPLEs, and Section 403b plans
b. DOES NOT INCLUDE Section 457 Plans
2. Active Participation Defined:
a. Defined Benefit Plan: EE is eligible to participate
b. Defined Contribution Plan: Annual addition is made on EE's behalf
124
Active IRA Participation Rules
1. IRA phases out based on AGI
2. Neither spouse is active participant
- NO AGI LIMIT
3. Taxpayer is ACTIVE Participant
- Single: $59,000 - $69,000
- MFJ: $95,000 - $115,000
4. Taxpayer is not Active Participant but Spouse IS:
- MFJ: $178,000 - $188,000
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Disadvantages Traditional IRA's
1. NOT established/funded after age 70.5
2. Distributions - Tax as Ordinary Income
3. 10% Penalty on W/D's < age 59.5
4. Excess Contributions - 6% excise tax
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Exceptions to IRA Penalty TAX
1. Exceptions (ME ADD HE)
- Medical Expenses > 7.5% AGI
- Equal payments (substantially equal period payments)
- Age > 59.5
- Death
- Disability
- Home purchase - first time ($10k max)
- Education - Qualified higher education expenses
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Prohibited Transactions for IRA's
1. Receiving -Unreasonable compensation for managing the IRA
2. Borrowing - Borrowing from or pledging as collateral
3. Buying - Buying property for personal use with IRA funds
4. Selling - Selling property to or buying assets from the IRA
*RUBBS
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Investments in IRA
1. Allowed
- C Corp stock, corp.gov debt, mutual funds
- US Gold and Silver Coins, Bullion
- Options, Commodities, Real Estate
2. Prohibited (IMPORTANT FOR TEST)
- Collectibles
- S Corporation Stock
- Life Insurance
- Foreign coins
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Roth IRA's
1. Eligible at any age
2. Must have earned income
3. AGI Phaseouts
- Single: $112,000 - $127,000
- MFJ: $178,000 - $188,000
- MFS: $0-$10,000
4. ER plan and Roth IRA
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Roth Contributions
1. Same limits as Trad IRA
2. $5,500 with a catch up of $1000
3. Excess contributions - 6% excise tax
4. NOT tax deductible
5. Contributions can continue beyond age 70.5
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Distributions Roth IRA
1. Distribution Order
a. Contributions
b. Conversions (FIFO)
c. Earnings
2. Qualified Distributions - Tax Free
a. After Five Taxable Years, and
b. On or after age 59.5, death, disability, or first-time homebuyer
3. Nonqualified distributions
a. 10% Penalty
b. Penalty not applicable to ME ADD HE
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IRA Withdraws Attributable to Conversion
Meets 5 year Holding Period Fails to Meet 5 Year Holding Period
Any Purpose ME ADD HE Any Other Purpose
No income tax No income tax No income tax
or 10% penalty or 10% penalty Yes 10% Penalty
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Tax Deferred Annuity (TDA)
403b
(TSA)
1. Tax deferred retirement plans; similar to Section 401k plan
- Section 403b, TDA's, TSA
2. Tax Exempt Organizations/Public Schools/Colleges
3. ER and EE contributions
- Not taxable to EE's
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Tax Deferred Annuity Rules
1. All new EE's must be notified when hired of opportunity to participate
2. No Discrimination
3. Must have written plan document outlining adm. responsibilities of ER
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Tax Deferred Annuity (TDA)
| Application/Features
1. ER must be
a. Tax exempt Section 501c3
b. Education Org
2. Features
a. Max contribution is $17,500
b. Plus $5,500 catch up
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Section 403b Special Catch-up Provision
1. Employee with 15 years of service
2. ER Section 501c3
3. Lesser of:
a. $3,000 (Only could do this for a maximum of 5 times)
b. $15,000 (Lifetime)
c. $5,000 times years of service less all prior salary deferrals
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TDA appropriate when
1. ER can afford minimal extra expense beyond existing salary and benefit costs.
2. TDA can be funded entirely from EE salary deferral
3. EE group has one of the following:
a. EE want a choice as to amount or rate of savings
b. Younger workforce
c. EE's willing to accept the risk
3. Qualifying ER wants a savings supplement to its existing retirement plans
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Tax Deferred Annuity (TDA)
Plan must meet one of three coverage tests:
1. Ratio Test - the Percentage of NHCE's who participate in the plan must be at least 70% of percentage of HCE's
2. Percentage Test - Plan must benefit a minimum of 70% of NHCE's
3. Average Benefits Test - (certain class of EE's can be excluded: part time students, nonresident aliens, etc) may be excluded as long as the plan does not discriminate in favor of HCE
a. The average benefit percentage for nonhighly compensated EE's must be at least 70% of the average benefit percentage for highly compensated EE's.
139
Tax Deferred Annuity TDA Features
1. In service withdrawals are generally permitted.
2. Because of non discrimination testing a 403b can be relatively costly and complex
3. ADP does not apply! 403b plans must comply with ACP test for matching contributions
4. EE's bear the risk
5. Life Insurance provided only as an incidental benefit to the retirement benefit in the plan
140
Special Catch UP Provisions for 403B, TSA/TDA
1. Salary reduction $17,500 + catch up of $5,500.
2. Special Catch Up (15 years of service)
a. $3000
b. $15,000 (lifetime)
c. $5,000 multiplied by EE's years of service minus sum of all prior salary deferrals
3. Order of Catch Up
Process: If the 15k life time has not been exhausted, the first $3000 of extra over $17,500 will apply to the $15k. If $5,500 was deposited, $3,000 would be classified as special catch up, and the $2,000 would be 50+ catch up.
Summary: It's possible EE age 50+ with 15 years of service can contributed $26,000 in any one year ($17,500 as elective deferrals, $5,500 as regular age 50+ catch up, and $3,000 under special catch up)
141
Tax Deferred Annuity Additional Features
1. Only the first $255,000 of EE's salary can be used to calculate any contribution.
2. TDA subject to annual limits: the lesser of100% compensation up to $51,000.
3. EE elective deferrals subject to FICA (Social Security & Medicare)
and FUTA (Fed. Unemployment)
4. Hardship W/D's - Earnings on EE's deferrals may not be withdrawn for hardship.
a. EE's deferrals may be distributed for hardship
b. Distribution may be subject to early w/d penalty in addition to ordinary income tax
142
Tax Deferred Plan Requirements
1. Written Plan
a. All Material Plan Provisions and allocate responsibilities
b. Plan must prohibit discrimination in favor of HCE's
c. When hired all Ee's must be notified of their opportunity to participate in the plan
2. Certain type of non tax transfer's permitted
3. Required 20% withholding on any eligible distribution that is not subject to rolled over to another plan
4. Special 15 year catch up contributions must be exhausted before using the age 50 catch up
143
Tax Deferred Annuity and ERISA
1. Gov. EE's and Non-electing Church Plans are exempt from Title 1 of ERISA
2. Plans consisting solely of EE contributions are exempt from ERISA
a. EE participation voluntary
b. ER association with the plan is solely on an unpaid and adm. basis
c. EE in complete control of annuity contract
d. If ER is authorized by the plan to determine EE's eligibility for hardship w/d or disability distributions, THE PLAN BECOMES suject to Title 1 ERISA and is not exempt.
144
Simple IRA Contributions
**NOT subject to Non Discrimination rules or top-heavy rules
1. EE Contributions (LOWER Contributions than other plans)
a. Max. $12,000
b. 50+ catch up $2,500
2. ER Contributioins
a. Match DOLLAR for DOLLAR up to 3% EE compensation (can reduce to 1% in up to two out of five years) OR
b. 2% of Compensation for Each Eligible EE (Maximum $255,000)
c. All Fully Vested: All EE and ER contributions
145
Tax Deferred Annuity, TSA
Lump sum distributions are not eligible for...
10 year forward averaging.
146
The EE may be required to recognize ordinary income upon the sale of ER stock acquired through an ESOP.
1. At date of disposition of the shares, the EE will recognize ordinary income on the basis of the lesser of,
a. The FMV of the stock at the grant date less the option price, or
b. The FMV of the stock on the disposition date (or date of death if sooner) less the option price.
147
For 2013, a worker receives 1 Social Security credit for each...
$1,160 in annual earnings on which SS taxes are withheld up to a maximum of 4 credits.
$1,160 x 4 = $4,640
148
Section 410b Coverage Rule is...
1. A retirement plan can cover any portion of the workforce, as long as it satisfied 1 of 3 Tests under Section 410b.
2. The coverage tests under Section 410b of the IRC are: the percentage test, the ratio test, and the average benefit percentage test.
149
SS Integration - If the Integration Level is less than the SS wage base...
1. Larger contributions will be made on behalf of EE's whose compensation is above the lower integration level.
2. The plan's cost to the ER increases as the integration level is reduced.
3. The permitted disparity between the maximum excess contribution percentage and the base contribution is reduced.
4 Optimum integration is generally just above the compensation level of the highest paid nonowner EE.
150
Cross Tested Plans are DC Plans that...
Test whether the contribution formula discriminates in favor of highly compensated EE by converting contributions made for each participant into equivalent benefit accruals.
151
Both a C Corporation and a General Partnership can
Hold and convey property
185
Defined Contribution Plans & Integration with SS
1. D.C. Plans ONLY Use Excess Method for SS Integration
2. Excess Method
a. Excess Method provides higher contributions above the integration level than below the integration level
b. The benefit level below the integration level is called the base percentage; the benefit level above the integration level is called the Excess Percentage
c. The Excess Percentage is limited to the lesser of (1) two times the base percentage or (2) the base percentage plus 5.7%.
d. The difference between the base percentage and the excess percentage, which is referred to as the maximum permitted disparity.
186
Defined Benefit Plan Integration
Maximum Permitted Disparity
1. Maximum difference between the benefit percentage below and above the covered compensation level is 3/4 of 1% multiplied by years of service up to 35 years.
2. Maximum increase in benefits for earnings above the covered compensation level is 26.25% (3/4 x .01 x 35)
3. This applies for both the excess and offset methods.
187
Integration with SS
| Permitted Disparity
1. Qualified plan benefit or contribution formulas can be integrated (permitted disparity) with SS (some exceptions)
a. Retirement benefits are one of the major benefits under SS System
b. EE's & ER's contributed to SS thru FICA
188
Defined Benefit Plan Integration
**Defined Benefit plans have two methods of Integration
1. Excess Method - the plan defines a level of compensation, call the integration level, and then provides a higher rate of contribution and benefits for compensation above the integration level.
2. Offset Method - a fixed amount or a formula amount that is designed to represent the existence of SS benefits reduces the plan formula.
189
FICA consists of two parts:
1. Old Age, Survivors & Disability Insurance (OASDI)
a. 12.4% (6.2% ER share and 6.2% EE share) of wages up to the SS wage base, which is typically increased each year.
2. Medicare - the Medicare tax portion equals 2.9% of wages with no limit and is paid by both the ER (1.45%) and the EE (1.45%)
191
Hybrid Plans
New Comparability Plan
1. Defined Contribution Plan - either money purchase pension or discretionary profits sharing plan
2. Groups/Classes of EE received different levels of contributions
3. Works well when EE's disparity in owner's ages
4. Can classify EE's based on yrs of service, job title, compensation levels, age or combination
5. Must pass nondiscrimination tests
6. Must have precise provisions to reallocate contributions if plan fails nondiscrimination testing
7. There has to be a plan in place, if it fails the discrimination testing, then it must have a way to make it non discriminatory.
211
Hybrid Plans
Age Based Profit Sharing Plan
1. Defined Contribution profit sharing plan
a. Allocations made are age adjusted compensation
2. Age adjustment uses discount factor based on EE age and interest rate selected by ER
3. Participant's accrual rates are the same
4. Equivalent accrual rates are basis of nondiscrimination testing
218
Hybrid Plans Target Benefit/Age Weighted/ Cross Tested
1. Allows higher contribution levels (as a % of compensation) for older participants
2. Types:
a. Traditional Target Benefit Plan
b. Age based Profit Shariing
c. New Comparability Plan
219
Hybrid Plans
Target Benefit/Age Weighted/Cross Tested Plans
1. As alternative to defend benefit plan to provide older EE's adequate retirement benefits at lower cost
2. ER wants to terminate existing Defined Benefit Plan
3. Closely held business or professional corporation has large numbers of key EE's age 50+
240
KEOGH Plans
1. Qualified Plan for one or more self employed
| 2. Remember: Based on Schedule C Net Earned Income, NOT W-2 INCOME
252
Simple 401k Plans Testing & Contributions
100% EE Vested all Contributions/Deferrals
1. Avoids ADP Test and Top Heavy Rules
2. EE contributions
a. Max. elective deferrals of $12k
b. Catch up $2,500
3. ER required Contributions
a. matching up to 3% compensation or
b. Nonelective 2% compensation for all eligible EE's
4. 100% Vested
