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CFP Pre-Study Flashcards > RP and EB - Lesson 2 (Pension Plans and Profit Sharing) > Flashcards

RP and EB - Lesson 2 (Pension Plans and Profit Sharing) Flashcards

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1
Q

How is the typical pension benefit calculated (ie. the base funding formula)?

A

(% per year of service) X (# of years of service) X (average of the 3 highest consecutive salary years)

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2
Q

Established to provide additional protection to lower wage participants of defined benefit plans.

A

PBGC - (Pension Benefit Guaranty Corporation)

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3
Q

The assets of a pension plan may be invested in the securities of the employer/plan sponsor BUT the aggregate value of the employer securities cannot exceed ____ % of the fair market value of the pension plan assets at the time the employer securities are purchased.

A

10%

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4
Q

Any securities issued by a plan sponsor or an affiliate of a plan sponsor including stocks, bonds, and publicly traded partnership interests.

A

Employer Securities

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5
Q

Under the Pension Protection Act of 2006 defined benefit pension plans can now provide for in-service withdrawals to participants age __________ .

A

62 and older

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6
Q

In addition to the 10% limitation, the Pension Protection Act of 2006 requires defined contribution plans holding publicly traded employer securities to allow plan participants to diversify - the employer must offer a choice of at least ________ investment options other than employer securities.

A

3

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7
Q

Premiums paid by the employer of a life insurance policy in a qualified plan are taxable to the employee when?

A

At time of payment

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8
Q

To maintain its qualified plan status, a qualified plan that includes life insurance must pass either (1) or (2).

A

(1) the 25% test

(2) the 100-to-1 ratio test

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9
Q

What are the rules of the 25% test?

A
  • If a Term or Universal Policy is purchased in a Qualified Plan, the aggregate premiums paid for the policy cannot exceed 25% of the employers aggregate contributions to the participants account
  • If a Whole Life Policy is purchased within a Qualified Plan, the aggregate premiums paid cannot exceed 50% of the employers aggregate contributions to the participants account
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10
Q

The entire value of life insurance must be converted into _________ or _______________________ at or before retirement.

A

Cash or Periodic Income

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11
Q

What is the 100-1 Ratio Test?

A

Limits amount of death benefit of life insurance purchased to 100 times the monthly-accrued retirement benefit

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12
Q

How are forfeitures allocated in a defined benefit pension plan vs a defined contribution pension plan?

A

Defined Benefit Pension Plan: Can be used to reduce future plan costs to employer

Defined Contribution Pension Plan: Can be used to reduce future plan costs OR allocated to other plan participants in a non-discriminatory manner

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13
Q

The PBGC does not insure defined contribution or profit sharing plans nor does it insure defined benefit pension plans of professional service corporations with _____ or fewer participants.

A

25

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14
Q

A participant in a defined benefit plan has an accrued benefit roughly equal to ___________________ .

A

The present value of the expected future payments at retirement

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15
Q

What type of plan is allowed to grant credit for prior service?

A

A defined benefit plan

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16
Q

If a defined benefit plan grants credit for prior years of service, it must do so in a ___________________ manner.

A

Non-discriminatory

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17
Q

______________________ often referred to as Social Security Integration, allows a higher contribution or allocation of benefits to employees whose compensation exceeds the SS wage base for the plan year - a sort of “reverse discrimination.”

A

Permitted Disparity

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18
Q

What are the 2 methods of permitted disparity?

A

1) The offset method

2) The excess method

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19
Q

This method (for both defined benefit and defined contribution plans) provides an increased percentage benefit to plan participants whose earnings are in excess of the covered compensation limit.

A

Excess Method

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20
Q

An average of the Social Security Wage bases over the 35-year period prior to the individuals Social Security Retirement Age.

A

Covered Compensation Limit

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21
Q

The increased percentage benefit in the excess method only applies to income that exceeds the covered compensation limit and is limited to the lesser of: (1) or (2)

The additional benefit only applies up to how many years?

A

(1) .75% per year of service
(2) the benefit percentage for earnings below the covered compensation limit per year of service

35 years

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22
Q

What is the covered compensation limit by definition? (for plans integrated with SS)

A

1) Plan participants whose earnings are excess of an 2) average of the Social Security wage bases 3) over the 35 year period prior to the individuals SS retirement age

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23
Q

What method provides an increased benefit to those individuals whose earnings are in excess of the covered compensation limit (for defined benefit plans only)?

A

Offset Method

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24
Q

The increased percentage benefit in the offset method applies a benefit formula to all earnings and then reduces the benefit on earnings below the covered compensation limit which is limited to the lesser of:

A

(1) .75% per year of service up to 35 years

(2) 50% of the overall benefit funding percentage per year of service

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25
Q

This type of qualified plan is generally considered to benefit older participants.

A

Defined Benefit Plan

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26
Q

What is the only type of defined contribution pension plan that utilizes an actuary at plan inception?

A

Target Benefit Plan

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27
Q

For a defined benefit plan what are the most common benefit formulas to determine the retirement benefit provided?

A

(1) The flat amount formula
(2) The flat percentage formula
(3) The unit credit formula

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28
Q

This formula provides that each participant will receive at retirement the same amount.

A

Flat amount formula

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29
Q

This formula provides that all participants will have a benefit equal to a percentage of the participants salary.

A

Flat percentage formula

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30
Q

This formula utilizes both a participants years of service and salary to determine the participants accrued benefit.

A

Unit Credit Formula

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31
Q

Benefit calculation for the following:

Flat Amount Formula
Flat Percentage Formula
Unit Credit Formula

A

Flat Amount Formula: Flat Amount per month

Flat Percentage Formula: Flat percentage based on compensation

Unit Credit Formula: Benefit determined on a combination of service and compensation

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32
Q

In this type of defined benefit plan each participant receives a statement for a separate account in his name with hypothetical values.

A

Cash Balance Pension Plans

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33
Q

A cash balance pension plan is generally more beneficial for _______________ participants because the formula is based on years of service.

A

younger

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34
Q

What type of vesting schedule does a cash balance pension plan use?

A

3 year cliff

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35
Q

This occurs when an employer changes from a traditional defined benefit pension plan into a cash balance pension plan.

A

Conversion

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36
Q

A hybrid plan must meet 3 main requirements:

A

(1) A participants accrued benefit would be greater than or equal to that of a similarly situated younger individual.
(2) Interest rate used to determine interest credit must not be greater than market rate of return
(3) For plans after 2007, the hybrid plan must provide 100% vesting after 3 years of service

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37
Q

For defined contribution plans, an employer cannot deduct contributions to the plan in excess of _______ % of the employers total covered compensation paid.

A

25%

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38
Q

This Act increased the contribution limit for profit sharing plans to 25% (from 15%) putting defined contribution pension and profit sharing plans on “equal contribution” levels.

A

EGTRRA 2001

39
Q

What type of vesting schedule are money purchase plans subject to?

A

2-6 year graduated or 3 year cliff

40
Q

What are 3 types of non-contributory plans?

A

Money Purchase Pension Plans
ESOPs
Profit Sharing Plans

41
Q

This type of plan formula may be written to provide a contribution to each participant during the plan year that is actuarially equivalent to the present value of the benefit at the participants retirement.

A

Target Benefit Pension Plan

42
Q

Contributions to profit sharing plans are generally discretionary but funding must be ________________ and _____________________ .

A

Substantial and Recurring

43
Q

Technique or method of allocating a plan contributions to employees accounts so that a higher contribution will be made for those employees whose compensation is in excess of the social security wage base.

A

Permitted Disparity

44
Q

Profit sharing plans basically establish two contribution rates, which are?

A

(1) The base contribution percentage rate

(2) The excess contribution percentage rate

45
Q

What is the base rate and excess rate applied to for employees earning income?

A

Base rate: applies to income earned up to integration level (SS wage base)

Excess rate: applies to income earned above the integration level, but only up to maximum covered compensation limit ($305,000) for the year

46
Q

The excess rate is generally the lesser of twice the base rate or _______ % higher than the base rate.

A

5.7%

47
Q

This type of plan is chosen when the employee census is such that the owner or key employee is older than most or all other employees and the company wants to tilt the contribution towards the older employees.

A

Age Based Profit Sharing Plans

48
Q

Generally a profit sharing plan in which contributions are made to an employees account based of their respective classification in the company as defined by the plan sponsor.

A

New Comparability Plans

49
Q

What are the options for forfeitures in a profit sharing plan?

A

1) Used to reduce plan contributions

2) Be reallocated (non-discriminatory) to remaining participants accounts

50
Q

These cannot be reallocated to participants accounts that have already reached their annual additions limit for the year.

A

Forfeitures

51
Q

What are the vesting rules for profit sharing plans?

A

The same as defined contribution plans: 3-year cliff or 2-6 year graduated (unless plan requires a 2 year waiting period)

52
Q

What are the 5 types of entities that may establish a 401(k) plan?

A

1) Corporations
2) Partnerships
3) LLC’s
4) Proprietorships
5) Tax Exempt Entities

53
Q

An employee cannot be required to complete more than _________ of service as a condition of participation in a 401(k) arrangement. Why?

A

1 year

Employee elective deferrals are already 100% vested

54
Q

Employee contributions to a 401k are ___________ vested.

Employer-matching contributions and earnings must vest under a schedule at least as generous as the __________________ or the _____________________ .

A

100%

3 year cliff OR 2-6 year graduated

55
Q

Generally these plans allow employees to make after tax contributions - most commonly utilized by individuals who want to save more than the elective deferral limit or more than amount allowed under ADP/ACP

A

Thrift Plan

56
Q

Describe each of the rules with a ROTH IRA:

1) Contribution Limit?
2) Catch up contribution limit (age 50)?
3) Income Limit?
4) Available for Loans?
5) Conversion from Trad. IRA allowed?
6) Qualified Distributions?
7) Required Distributions?

A

1) $6,000
2) $1,000
3) MFJ: 204k - 214k, Single: $129k - $144k, MFS 0-$10k (Modified AGI)
4) No
5) Yes
6) Account held for 5 years and distribution must be made on account of a first home purchase, disability, death, or after/on attainment of 59.5 age
7) None

57
Q

Describe each of the rules with a ROTH 401(k) account:

1) Contribution Limit?
2) Catch up contribution limit (age 50)?
3) Income Limit?
4) Available for Loans?
5) Conversion from Trad. IRA allowed?
6) Qualified Distributions?
7) Required Distributions?

A

1) $20,500
2) $6,500
3) No income limits (must be income deferral)
4) Yes
5) No
6) Account held for 5 years and distribution must be made on account of a disability, death, or after/on attainment of 59.5 age
7) Follows RMD rules

58
Q

What are the RMD rules (when must they be taken)? (2022)

A

Must take minimum distribution by April 1st in the year following the year in which participant reaches 72.

59
Q

Employer matching contributions must vest as rapidly as either a _______________ or a ____________ .

A

3 year cliff vesting schedule or a 2-6 year graduated vesting schedule

60
Q

When plan sponsors elect to contribute to all eligible employees, whether they elect to defer compensation or not. What are these contributions called?

A

Non-elective Contributions

61
Q

What are the 2 nondiscrimination tests in qualified plans?

A

1) ADP Test

2) ACP Test

62
Q

If the Actual Deferral Percentage for NHC’s is:

0% to 2% :
2% to 8% :
8% and over :

What is the permissible ADP for HC employees?

A

0% to 2% : 2 times ADP for NHC’s
2% to 8% : 2% plus ADP for NHC’s
8% and over : 1.25 times ADP for NHC’s

63
Q

Failing the ADP or ACP tests puts the plan at risk for disqualification, what are the 4 alternative remedies available to bring a plan into compliance?

A

1) Corrective Distributions
2) Recharacterization
3) QNEC (Qualified Non-Elective Contributions)
4) Qualified Matching Contributions (QMC)

64
Q

What does ADR and ACP stand for?

A

Actual Deferral Ratio

Actual Contribution Percentage

65
Q

If the HC definition is without election this means:

A

That employee does not have to be in the top 20% of employees to be considered HC

66
Q

If the HC definition is with election this means:

A

That employee has to be in the top 20% of employees to be considered HC

67
Q

These are not counted in limitations when doing ACP and ADC testing?

A

Catch up contributions

68
Q

When a plan fails the ADP test, the easiest (and usually cheapest) solution to reduce the elective deferrals of HC’s is ______________________ this is called ________________ .

A

By distributing or returning funds to HC’s, called a Corrective Distribution

69
Q

When must corrective distributions be completed? What happens if they are not completed in time?

A
  • Within 2.5 months after the end of the plan year
  • If not completed, a 10% excise tax is imposed on the amount that should have been distributed

(Earnings accumulated during this time must also be distributed back to HC’s)

70
Q

A solution used by employers/plan sponsors when trying to correct distributions after a failed ADP test is to treat excess deferrals as after-tax employee deferrals called _________________ .

A

Recharacterization

71
Q

Recharacterization must be completed within _______________ after the end of the plan year at which time these contributions are taxable to the employee. If not completed the employer is subject to a _______________ excise tax.

A

2.5 months

10%

72
Q

These are considered to be elective deferrals made by the employee for purposes of discrimination testing. Employer may choose this to all eligible NHC employees to increase ADP for purposes of passing the test.

A

Qualified Non-Elective Contributions (QNEC)

73
Q

QNEC’s are _______ % vested when contributed.

A

100%

74
Q

Is a contribution made by a plan sponsor that increases the ADP of NHC employees and is only made to those eligible NHC employees who participated in the plan during the plan year.

A

Qualified matching contributions

75
Q

What is the difference between QNEC and QMC?

A

QMC only for eligible NHC employees who participated in the plan during the year. QNEC are for all eligible employees whether they participated or not.

76
Q

The IRC provides a provision whereby the employer is not required to comply with the ADP Test, the ACP Test, or Top-Heavy Testing.

A

Safe Harbor 401(k) plans

77
Q

An election can be made 30 days prior to the close of the plan year to convert a 401(k) plan to a non-elective 401(k) safe harbor status. If the election is made to convert within 30 days of the plan year end, then:

A
  • The non-elective contribution must be at least 4% for all eligible employees
  • The plan must be amended no later than the last day for distributing excess contributions for the plan year
78
Q

What is the standard safe harbor match formula?

A

100% of first 3% of employee elective deferrals and additional 50% of employee elective deferrals greater that 3% and less than 5% (see page 64)

79
Q

Non-elective matching contributions must have a vesting schedule of no longer than:

A

2-year cliff

80
Q

For loans from a qualified plan a participant may borrow no more than ______% vested balance or $_____________ whichever is less.

A

50%

$50,000

81
Q

Defined contribution profit sharing plans that allow employers to contribute stock to a qualified plan on behalf of their employees.

A

Stock bonus plan

82
Q

What are the type of distributions in a Stock Bonus Plan versus a Profit Sharing Plan?

A

Stock Bonus Plan generally stock

Profit Sharing Plan generally cash

83
Q

When is valuation needed in a Stock Bonus Plan versus a Profit Sharing Plan?

A

Annually in Stock Bonus Plan vs Rarely in Profit sharing

84
Q

Is there a diversification option in either a Stock Bonus Plan or a Profit Sharing Plan?

A

Only in a Profit Sharing Plan

85
Q

Which plan type has voting rights? Stock Bonus Plan versus a Profit Sharing Plan?

A

Stock Bonus Plan

86
Q

How are Stock Bonus Plan versus a Profit Sharing Plan generally distributed?

A

Stock Bonus Plan in stock (qualifies for NUA)

Profit Sharing plan in cash

87
Q

What is the taxation of a Stock Bonus Plan versus a Profit Sharing Plan?

A

Stock Bonus Plan - Lump Sum distributions qualify for NUA treatment, Rollovers are treated as ordinary income

Profit Sharing Plan - Generally taxed at ordinary income

88
Q

If a stock bonus plan provides the employee with the option of receiving cash and it is elected, what does the employee lose?

A

NUA benefit

89
Q

If the distribution of employer stock is made in installments, rather than lump sum, the employee may only defer recognition of the appreciation of the stock purchase with _________________________ .

A

After tax employee contributions

90
Q

What is the NUA benefit?

A

If taking a stock bonus plan as a lump sum distribution, it allows for paying the basis contributed at ordinary income and deferring the long term capital gains.

91
Q

If someone is taking a lump sum distribution from a stock bonus plan they will have to pay ordinary income on the basis, but will not have to realize net unrealized appreciation on the remainder until when?

A

The stock is disposed of

92
Q

What happens when an employee participating in an ESOP reaches 55 with 10 years of participation in the ESOP plan?

A

The employer must offer them some type of diversification options

93
Q

What are the main 2 differences between stock bonus plans and ESOPs?

A

ESOPs do not have integration with SS like Stock Bonus Plans and the deductible contribution limit is 25% of covered comp PLUS interest paid on the loan for ESOPS

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