Retirement Practice Exam Flashcards
Which retirement plans would permit a single employee making $100,000 a year to make still a fully deductible $6,000 contribution to an IRA?
a) 401(k)
b) 403(b)
c) SEP
d) 457
e) Defined benefit plan
Answer: D
A 457 Plan is not a qualified plan or SEP. A 457 plan is a deferred compensation plan and, therefore, would not prevent a participant making $100,000 from having a deductible IRA. Participants in a SEP and the three other plans (401(k), 403(b), and defined benefit plan) are considered to be “active participants.” They would be precluded from making a deductible IRA contribution at the $100,000 income level.
An employee retired under a defined benefit retirement plan at the end of 20x3. Her highest consecutive annual salaries were $90,000, $100,000, and $110,000, respectively, in 20x1, 20x2, and 20x3. What could maximum yearly benefit have been paid to her under the plan?
a) $30,000
b) $90,000
c) $100,000
d) $220,000
e) There is no limit on benefits under a defined benefit plan.
Answer: C
The maximum benefit under a defined benefit plan cannot exceed the average of the three highest consecutive earnings years within the limit of covered compensation.
Which combination of the following statements is correct about a 401(k)?
- The employee must have a choice of receiving an employer contribution in cash or having it deferred under the plan.
- Section 401(k) states that during the first year of participation in a qualified CODA, the vested benefit derived from employee contributions can be forfeited if the employee is terminated.
- As a condition of participation, the plan requires that an employee complete at least three years of service with the employer.
- In addition to an indexed limitation for any taxable year on exclusions for elective deferrals, the law caps the amount of pay that can be considered for qualified plans.
a) (1), (2), and (3) only
b) (2) and (4) only
c) (4) only
d) (1) and (3) only
e) (2), (3), and (4) only
Answer: C
Statement #1 is incorrect. Statement #4 is correct; the 2022 limit for covered compensation is $305,000.
Under CODA, employees can elect either to participate and contribution to the retirement plan or retain their
compensation and not participate.
Which of the following is/are true about a rabbi trust?
- The trust is revocable, and the employer can always rescind it.
- The employer may fund the trust from the company’s general assets.
- Employer contributions to the trust are exempt from payroll taxes.
- The trust’s assets may be used for purposes other than discharging the obligation to the employee.
a) (1), (2), and (3) only
b) (1) and (4) only
c) (2), (3), and (4) only
d) (2) only
e) (4) only
Answer: C
A rabbi trust is generally used with a non-qualified deferred compensation plan. Statement #1 is false; the trust is not revocable. Statement #3 is valid for employer contributions. Option C is correct. Assets in the trust can be used to discharge the employer’s indebtedness. This creates a substantial risk of forfeiture and allows the deferred compensation not to be treated as taxable income.
According to ERISA, which of the following is/are required to be distributed automatically to defined benefit plan participants or beneficiaries?
- Annual accrued benefit as of the end of the previous year
- The plans summary annual report
- A detailed descriptive list of investments in the plan’s fund
- Terminating employee’s benefit statement
a) (1), (2), and (3) only
b) (1) and (2) only
c) (2) and (4) only
d) (4) only
e) (1), (2), (3), and (4)
Answer: C
The plan’s summary annual report (Statement #2) must be distributed, and a benefit statement for terminated employees (Statement #4) must be distributed. Statements #1 and #3 are false.
Which of the following is/are true concerning non-qualified deferred compensation plans?
- They can provide for the deferral of taxation until the benefit is received.
- They can provide for fully secured benefit promises.
- They can give an employer an immediate tax deduction and an employee a deferral of tax
a) (1) only
b) (2) only
c) (3) only
d) (1) and (3) only
e) (2) and (3) only
Answer: A
Statement #1 is true. Statement #2 is false; if the benefit cannot be entirely secure, the participant has a substantial risk of forfeiture; therefore, it avoids current taxation. Statement #3 is false; the employer cannot receive a tax deduction until the income is taxable to the employee.
Joe is considering taking a position with a new employer at a salary of $150,000. His salary would make him a highly compensated employee in the new company. His previous employer, where he also earned $150,000, has been making the maximum allowed contributions to a money purchase plan. The new company has a 401(k) plan. Joe wishes to continue the highest possible pretax deferred savings for retirement. Identify all the options available to Joe through the new employer’s 401(k) plan.
- Have salary deferrals made in his new 401(k) plan equal the amounts his previous employer contributed to his profit-sharing plan.
- Take advantage of employer matching in the 401 (k) plan, if available.
- Have the employer make qualified non-elective contributions to his account, if available.
- Contribute the maximum allowable through salary deferral.
a) (1) and (2) only
b) (1), (2), and (3) only
c) (2) and (4) only
d) (2), (3), and (4) only
e) (3) and (4) only
Answer: C
Statement #1 is false; the limit on 401(k) plans is $20,500 (2022), and his former employer was contributing 25% of compensation, approximately $37,500. Statement #2 is true. Statement #3 is false; this technique increases amounts of non-highly compensated employees to meet the ACP test. Statement #4 is true.
Jack Jones, age 40, earning $100,000 a year, wants to establish a defined contribution plan. He employs four people whose combined salaries are $60,000 and range in age from 23 to 30. The average employment period is 3½ years. Which vesting schedule is best suited for Jack’s plan?
a) 3-year cliff vesting
b) 3-to-7-year graded vesting
c) 5-year cliff vesting
d) immediate vesting
e) 2-to-6-year graded vesting
Answer: E
This is a top-heavy plan, as evidenced by Jack’s salary compared to other employees. The choices for vesting schedules in a top-heavy plan are (a) immediate, (b) 3-year cliff, and (c) 2-to-6-year graded. Due to the average length of employment, the most suitable vesting schedule from Jack’s point of view (cash flow if termination occurs and forfeiture) is the graded vesting schedule. Options B and C would be unavailable to Jack.
Your client, ABC Corporation, is considering implementing some form of retirement plan. The client states its objectives for a plan to be, in the order of importance:
- Rewarding long-term employees
- Retention of employees
- Providing a level of income at retirement equal to 50% of an employee’s earnings
- Tax-deductible funding
- No risk to employees of benefits available
The company indicates it is willing to contribute an amount equal to 30% of payroll to such a plan. The
company has been in business for 22 years and, during the past decade, has consistently been profitable. They furnish you with an employee census. Based upon the stated objectives, you advise ABC Corporation that the most suitable retirement plan for the corporation would be:
a) Money purchase pension plan.
b) Non-qualified deferred compensation plan for long-term employees.
c) Combination of defined benefit and 401 (k) plan.
d) Defined benefit plan.
e) Profit-sharing plan.
Answer: D
Objective #5 answers the question. Only a defined benefit plan will benefit employees without risk to the employees. Rewarding long-term employees explains why the correct answer is not Option C. Implementing a 401(k) plan will not help long-term employees.
In a money purchase pension plan that utilizes plan forfeitures to reduce future employer plan contributions, which of the following components must be factored into calculating 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
a) (1), (2), and (3) only
b) (1) and (3) only
c) (2) and (4) only
d) (4) only
e) (1), (2), (3), and (4)
Answer: D
Statement #1 is not correct because forfeitures will be used to reduce contributions. Annual earnings never impact contributions to a defined contribution plan. Rollover contributions do not impact yearly additions. However, employee and employer contributions in total for all plans cannot exceed the lesser of 100% of an employee’s compensation or $61,000. Therefore, Statement #4 must be considered.
A client’s employer has recently implemented a Cash Or Deferred Arrangement (CODA) as part of his profit-sharing plan to incentivize his employees. The client is advised not to elect to receive the bonuses in cash but to defer receipt until retirement for the following reasons?
- The client will not pay current federal income taxes on amounts paid into the CODA.
- The client will not pay Social Security (FICA) taxes on amounts paid into the CODA
- The accrued benefits derived from elective contributions are nonforfeitable.
- The accrued benefits from non-elective contributions are nonforfeitable.
a) (1), (2), and (3) only
b) (1) and (3) only
c) (2) and (4) only
d) (3) only
e) (1), (2), (3), and (4)
Answer: B
Under a 401(k) plan, deferrals are not subject to income tax but to payroll taxes (FICA). In addition, these deferrals are not subject to forfeiture since they are the employee’s contributions.
Which statement (s) is/are true regarding qualified profit-sharing plans?
- A company must show a profit to contribute 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,” according to the IRS.
a) (1), (2), and (3) only
b) (1) and (3) only
c) (1), (2), and (4) only
d) (1), (2), (3), and (4)
e) (4) only
Answer: E
Statements #1, #2, and #3 are all incorrect regarding profit-sharing plans. Statement #4 is correct.
The maximum retirement benefit a participant in a target-benefit plan can receive depends on the following:
a) Initial actuarial computation according to the plan’s formula.
b) Amount of contributions determined about the targeted benefit.
c) Maximum annual additional amounts.
d) Value of the participant’s account at retirement.
Answer: D
Maximum retirement benefits from all defined contribution plans are dependent on the value of the participant’s account at retirement. A target benefit plan is both a pension plan and a defined contribution plan.
SJ, Inc. covered the following employees under a qualified plan.
- Joan, a 10% owner and employee with compensation of $45,000.
- Lind, a commissioned salesperson with compensation of $200,000 last year (the highest-paid employee)
- Reilly, the chief operating officer, had compensation of $150,000 last year but was not in the top 20% of paid employees.
- Garner, the president, who was in the top 20% of paid employees with compensation of $195,000
Assuming the company made the 20% election when determining who is highly compensated, which of the following statements is correct?
a) Exactly three people are key employees.
b) Exactly two people are highly compensated.
c) Joan is a key employee but is not highly-compensated.
d) Reilly is neither highly compensated nor a key employee.
Answer: D
For 2022, a key employee is an employee who, at any time during the plan year or prior year, met one of the following definitions:
A greater than 5% owner;
A greater than 1% owner with compensation > $150,000 (not indexed); or
An officer with compensation over $200,000.
Therefore, the Key Employees are Joan (> 5% owner) and Garner (an officer with a comp > $200,000).
In 2022 highly compensated employees are employees that are:
A more than 5 percent owner at any time during the plan year or preceding plan year, or
An employee with compensation above $135,000 for the prior plan year, and if elected, is in the top 20% of paid employees ranked as to compensation.
Therefore, the Highly Compensated Employees are Joan (> 5% owner), Lind (comp > $120,000 and in the top 20%), and Garner (comp > $120,000 and in the top 20%). Reilly has compensation greater than $120,000, but the problem tells you that he was not in the top 20% of paid employees.
Stephen, age 60, participates in the stock bonus plan of Simi, Inc., a closely held corporation. Stephen received contributions in shares to the stock bonus plan, and Simi, Inc. took income tax deductions as follows:
Year 1 - 500 shares valued at $10 per share at the time of contribution.
Year 2 - 100 shares valued at $12 per share at the time of contribution.
Year 3 - 250 shares valued at $14 per share at the time of contribution.
Year 4 - 200 shares valued at $16 per share at the time of contribution.
Year 5 - 50 shares valued at $18 per share at the time of contribution.
Stephen terminates employment and takes a distribution from the plan of 800 shares of Simi, Inc., having a fair value of $20,000. He sells the stocks for $25,000 6 months later. What is Stephen’s long-term capital gain treatment, and when is it taxed?
a) $0
b) $5,000
c) $6,200
d) $11,200
Answer: A
This question is tricky! It looks like an NUA question; however, it is not. In this case, Stephen did not take a lump-sum distribution and therefore did not qualify for NUA treatment. All of distribution will be subject to ordinary income and all of the remaining growth will be short-term capital gain at the time of sale since he only held it six months from distribution.