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CFP - Pass the Exam > Retirement Savings/Income Planning - 18% - 30 of 170 questions > Flashcards

Retirement Savings/Income Planning - 18% - 30 of 170 questions Flashcards

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1
Q

F 47 a - Distinguish between (name) each qualified plan, government plans, non-qualified and private tax-advantaged retirement plans.

A

Qualified:
- Defined Contribution (Traditional Profit sharing, Section 401k plan, Stock Bonus Plan, ESOP, Money Purchase Pension Plan and Target Benefit Pension Plan
- Defined Benefit - Tradition DB Pension and Cash Balance Pension Plan
- Government 403(b) and 457(b)

Tax-Advantaged (IRA based): - SEP (simplified EE pension), SIMPLE (savings incentive match for EEs)

Non-Qualified Deferred Compensation plans - aka Top Hat plans, Excess Benefit Plans, Supplemental Executive Retirement Plan (SERP), Rabbi Trust, Section 162 Bonus Plan

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2
Q

Employer chooses:
- Currently deductible ER plan contributions
- Benefits not currently taxable to the EE/participant

Which plan(s) would you recommend?

A

Qualified Plan
or
Tax Advantaged Plan

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3
Q

Employer chooses:
- Currently deductible ER plan contributions
- Employer can limit participation to select individuals (pick and choose)

Which plan(s) would you recommend?

A

Non-Qualified Section 162 Bonus Plan

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4
Q

Employer chooses:
- Benefits not currently taxable to the EE/participant
- Employer can limit participation to select individuals (pick and choose)

Which plan(s) would you recommend?

A

Non-Qualified Deferred Compensation Plan

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5
Q

DC Plan Features
- who directs accounts?
- limits?
- who bears risk?
- is final benefit guaranteed?
- insurance?
- vesting?
- who’s favored?
- max ded ee contribution?

A
  • Participant directed accounts
  • Combined EE/ER contributions subject to annual additions $69k
  • Maximum elective deferral $23k
  • Max Compensation considered $345k
  • Particpant bears investment risk
  • No guaranteed final benefit
  • No PBGC insurance
  • Favor younger participants
  • Vesting must be at least as generous as 3 yr cliff or 2-6 yr graded
  • Max deductible employer contribution is 25% of covered payroll
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6
Q

Traditional Profit Sharing Plan

A
  • flexible ee contributions (no requirement for annual contributions; “substantial and recurring” for 3 of last 5 years
  • 100% ER funded
    -** yearly profit not required **(er can use retained earnings/cashflows)
  • may invest 100% in ER stock
  • not subject to QJSA
  • “age-weighted” traditional profit-sharing plan can skew contributions to older participants
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7
Q

Stock Bonus Plan

A

basic plan - ER contributions made into ER stock as part of retirement plan

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8
Q

ESOP

A

Complex - Employee Stock Ownership Plan
offers tax advantages and gives EEs larger stake in company
- use borrowed money to purchase stock - aka “leveraged ESOP”
- trust borrows from bank, trust uses loan to purchase stock, ER makes deductible contribution to plan, trust pays back loan and bank releases stock
- if not publically traded, participants receive put option to sell stock back to plan

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9
Q

Section 401(k) Plan

A
  • “Cash or Deferred Arrangment (CODA)” usually added to profit-sharing plan
  • Elective deferrals up to lesser of: (1) 100% comp (2) $23k plus 50+catch up of $7,500 – CATCH UP IS NOT INCLUDED IN ANNUAL ADDITIONS LIMIT
  • ## ER not required to contribute annually but usually makes matching contribution&raquo_space; typically formula matching contributions (ER matches salary reductions $/%), discretionary matching contributions (ER matches a % of the % EE reduced - ie. 40% of EE’s salary reduction), pure discretionary or profit sharing contributions (based on EE’s compensation, regardless of EE salary reduction amount), or formula contributions (3% for EEs with comp under $50k)
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10
Q

QNEC’s - Qualified Non-Elective Contributions
401k

A
  • immediately 100% vested and are subject to the same withdrawal restrictions applicable to elective deferrals.
  • automatically made by the employer and cannot be opted out of by the employee.
  • The primary reason for making QNECs is to pass IRS mandated nondiscrimination tests, like the Actual Deferral Percentage (ADP) test, by providing additional contributions to non-highly compensated employees (NHCEs).
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11
Q

ADP Test

A
  • Elective deferrals in a traditional 401(k) plan must meet a special test for nondiscrimination, the ADP test.
  • No ADP testing is necessary for SIMPLE 401(k) plan or a safe harbor plan if the plan satisfies one of two alternative ADP tests as follows:
    • The ADP for eligible HCEs is not more than the ADP of all other eligible employees for the preceding plan year multiplied by 1.25.
    • The ADP for HCEs does not exceed the ADP for other eligible employees for the preceding plan year by more than 2% and the ADP for HCEs is not more than the ADP of all other eligible employees for the preceding plan year multiplied by two.
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12
Q

Highly Compensated Employee (HCE)
vs
Key EE

A
  • HCE - greater-than 5% owner of the employer, OR received over $155,000 (2024)
  • Key EE - greater than 5% owner, OR officer having annual comp greater than $220,000, OR greater than 1% owner whose salary exceeds $150,000

Applications!!
HCE - always be HCE greater than 5% owner, regardles of salary; ADP/ACP testing for 401k plans; coverage tests: safe harbor test, ratio test, avg benefit test
Key EE - important for Top Heavy testing, qualified plans, and group life insurance

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13
Q

Safe Harbor 401(k) Plans

A
  • No need for the ADP/ACP test thus allowing HCEs to contribute the max elective deferral amount.
  • Can only be added to a plan at the beginning of a new plan year, after providing employees with advance written notice of the change.
  • Require either a minimum matching contribution or a non-elective contribution for all eligible employees.
  • Must be immediately vested.
  • ER must provide one of these options:
    1. Matching Contributions must equal 100% of the first 3% of employee contributions and 50% of the next 2% of employee contributions, or
    2. Non-Elective Contributions for all eligible employees equal to 3% of their compensation.
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14
Q

Money Purchase Pension Plan

A

® Mandatory annual ER contributions (contribution guaranteed; not final benefit)
® 100% ER funded
® 10% ER stock
® defines ER contributions, typically by % of ee comp
® no withdrawals until 62
® subject to QJSA - default payout = Joint & survivor annuity
® Easy to understand
® Form 5500

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15
Q

Target Benefit Pension Plan

A
  • 100% ER funded; 10% ER stock
  • Actuary used only in the initial year
  • Final benefit not guaranteed
  • can be adjusted to skew higher plan contributions to older participants
  • ER contributions not aggregated across ERS if particiapnt has multiple jobs with different plans
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16
Q

When are contributions aggregated?
Not aggregated?

A
  • ER contributions are NOT aggregated across multiple ERs
  • EE contributions ARE aggregated across different ERs
17
Q

DB Plan Features
* Is final benefit guarnteed?
* PBGC insured?
* Vesting?
* payout?
* who bears investment risk?
* is actuarial work required?
* which rule must me satisfied?

A
  • Guarantee Final Benefit
  • Max annual pension $275k and max considered comp $345k (TT)
  • Insured by PBGC
  • Must vest at least as generously as 5 years, or 3-7 yr graded (Cash Balance plan must use 3 yr cliff)
  • Must have Joint & Survivor payout unless waived
  • no participant directed account; sponsor bears investment risk
  • no predetermined max deductible ER contribution
  • annual actuarial work required
  • must satisfy 50/40 rule (must cover 50 ees, or 40% non-excludable ees)
18
Q

Traditional Defined Benefit Plan

A
  • Guarantees monthly pension
  • mandatory annual contributions
  • Expensive
  • Established/profitable company
  • older/high-earning participants can have substantial funding on their behalf
  • % of pay x # years service
  • no individual accounts
  • accruing a benefit of any amount = active participation for IRA deduction purposes
  • if married, joint and survivor, unless spouse waives
19
Q

Cash Balance Plan

A
  • 3yr cliff only
  • “hypothetical” participant accounts for record keeping
  • guaranteed cash balance (lump sum) at normal retirement age
  • each year participant accrues a plan contribution based on a “pay credit” (% of comp) plus an interest rate credit
  • provides uniform benefit payment accrual for all ees
  • participant can convert guaranteed cash balance into lifetime pension
  • Easier to understand for participants vs Tradional DB plan
20
Q

403(b) Plan (TSA)

A
  • Tax advantaged salary reduction offered by 501(c)(3) orgs ie. schools/hospitals
  • before tax contirutions, tax deferred growth and income
  • salary reduction up to $23k - pre tax contribution
  • special catch up for 15 years of service with same employer $7500
  • 50+ catch up = $3000
  • $23k + $7500+$3000 = $33,500
  • RMD at 73
  • 10% penalty prior to 59 and half
  • aggregated with other plan EE deferrals
  • only invest in approved mutual funds and annuities
21
Q

457(b)

A
  • tax advantaged salary reduction plan used by gov’t and certain non-profits
  • Tax advantaged salary reduction offered by 501(c)(3) orgs ie. schools/hospitals
  • salary reduction up to $23k - pretax contribution
  • special catchup = last 3 years of service; up to 2x = $46k
  • age 50+ catch up $7500; cannot be used with special catch up
  • NO 10% penalty prior to 59 and half
  • RMDs at 73
  • EE deferrals NOT aggregated
  • NOT considered active participant for IRA ded purposes
22
Q

Section 415

A

provides dollar limits on qualified plans
- governs annual additions limit lesser of:
- $69k
- 100% of comp

Includes: ER and EE contributions and forfeitures

23
Q

Simplified Employee Pension
(SEP)

A
  • use IRAs as funding accounts
  • Easy
  • ER with 1+ ees
  • no annual filing requirement; plan may be funded up to due date to ERs tax return including extensions
    * ER contributions only; 100% ER funded
  • up to 25% covered comp no more than $69k
  • ER can decide whether to make contributions year to year
  • must be offered to 21+ yr olds employed last 3 of 5 years and had comp over +$750
  • withdrawals subject to income tax and additional tax; NO loans
  • contributions vest 100% immediately
  • EE deferrals aggregated
24
Q

SIMPLE IRA

A
  • use IRAs as funding accounts
    * little admin work
    * ER with 100 or fewer ees w/ no other retirement plan
    * no annual filing requirement; bank handles paperwork
    * ER AND EE contributions
    * Max annual contribution
    - EE: $16,000; 50+ additional $3,500
    - ER: either match ee contributions 100% for first 3% of comp (can be lowered to 1% in any 2 of 5 years OR contribute 2% to ALL ees (even if ees aren’t making deferrals)
    * ER must make matching contributions or contribute 2% of comp
    * must be offered to all EEs making $5k+ in any 2 prior years and reasonably expected to earn $5k+ this year
    * withdrawals income tax + 10% early withdrawal penalty; withdrawals within 2 years of enrollment subject to 25% penalty; NO loans
    * contributions vest 100% immediately
  • EE deferrals aggregated
25
Q

Funded vs Unfunded Plans

A
  • Funded: In the tax sense, a plan is formally funded if the employer has set aside money or property to pay plan benefits through some means that restricts access to the fund by the employer’s creditors.
  • Funded plans subject to ERISA 3yr cliff or 2-6yr graded vesting and fiduciary requirements
  • Unfunded: fund is accessible by ER and it’s creditors

An unfunded arrangement is one where the employee has only the employer’s “mere promise to pay” the deferred compensation benefits in the future, and the promise is not secured in any way.

A funded arrangement generally exists if assets are set aside from the claims of the employer’s creditors, for example in a trust or escrow account. In the unfunded plan, the tax consequence will be determined on the Doctrine of Constructive Receipt.

If there are no substantial limitations or restrictions, the amount is not deferred and is currently taxable.

26
Q

F48 c. Explain the fiduciary responsibilities of employers with respect to the investments in their firm’s qualified plan under ERISA.

A

DC plan / plan where participant bears risk:
* participant-directed account = plan trustee is generally relieved of fiduciary responsibility for any losses resulting from an investment chosen by the participant.
* at least three different diversified investment alternatives be made available to the employee. Life insurance can be used in the plan.

DB Plan - Employer / Sponsor bears risk (in education it says employer, in review material it says sponsor)

27
Q

Average Benefit Test
(1 of 3 Non Discrimination Tests)

A

The average benefit is calculated as a percentage of compensation.

The total average benefit for all non-HCEs must be at least **70% of the average benefit for HCEs**

28
Q

Ratio Percentage Test
(1 of 3 Non Discrimination Tests)

A

Ratio Percentage Test - most common and simplest method to pass coverage testing

Step 1
Non-HCE x .70 = minimum coverage needed

Step 2:
Non-HCEs - excluded EEs   =   Non-HCE coverage ratio
   Total Non-HCEs

Step 3: 
Total HCE - excluded EEs    =    HCE coverage ratio
        Total HCE

Step 4:
Non-HCE coverage ratio / HCE coverage ratio = Ratio Percentage Test

Step 5: If Ratio Percentage test (step 4) is higher than Minimum Coverage Needed (step 1)
29
Q

Safe Harbor Test
(1 of 3 Non Discrimination Tests)

A

covers at least 70% of Non-HCEs

12 sales + 26 office = 38 total staff
11+6 = 17 HCE >> 38 - 17 = 21 Non HCEs
21 * .7 = ~15; at least 15 employees that must be covered
doesn’t want to cover sales (12 total, 11 of which was HCE, 1 Non HCE)
21 Non HCEs - 1 sales Non HCE= 20 covered = PASS
30
Q

F.47 Types of retirement plans
a. Distinguish between qualified, government, non-qualified and private tax-advantaged retirement plans.

A

qualified -
- subject to annual IRS limit
- creditor protection in bankruptcy
- comply with ERISA
- ee’s can deduct their contributions and enjoy tax-sheltered growth on investments
- er’s get to deduct their matching contributions, and ee’s don’t have to claim these amounts as income

government
- 457 - A governmental Section 457(b) plan is a tax-advantaged salary reduction retirement plan used by government and certain non-profit organizations.
- A Section 403(b) plan (TSA) is tax-advantaged salary reduction retirement plan often used by Section 501(c)(3) tax-exempt organizations (e.g., hospitals) and public schools.

non-qualified
- do not meet ERISA requirements and are discriminatory 
- provide employees additional retirement benefits, but do not provide same tax benefits or creditor protections that qualified plans do
- ER can’t deduct their contributions until contribution becomes taxable to EE
- offer ER flexibility when designing the plan. 
- ER can decide who is to be included in the plan. He may want to include only the highly compensated employees or members of management.
- no required vesting schedule

private tax-advantaged retirement plans

- Easy to set up
- use IRA’s as funding account
- 100% vested

CFP - Pass the Exam (6 decks)

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