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Retirement Savings and Income Planning > Types of Retirement Plans > Flashcards

Types of Retirement Plans Flashcards

1
Q

What are qualified retirement plans?

A
  • Employer-sponsored plans that must follow a unique set of rules and requirements to maintain its qualified status
  • Rules are established in Section 401(a) of the IRC
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2
Q

What are the two broad categories of qualified plans?

A
  • Pension plans
  • Profit sharing plans
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3
Q

What are the pension plans?

A
  • Defined benefit
    • Cash balance pension
    • Defined benefit pension
  • Defined Contribution
    • Target benefit pension
    • Money purchase pension
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4
Q

What are the profit sharing plans?

A
  • These are ALL defined contribution plans
    • Profit sharing plans
    • 401k plans
    • Thrift plans
    • Age-based profit sharing plans
    • New comparability plans
    • Stock bonus
    • ESOP
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5
Q

Characteristics of Pensions Plans

A
  • Pays benefit to participant, usually for duration of their life
  • Some pension plans require actuary for minimum funding standards
  • Limited in amount they can invest in employer stock (10%)
  • Must provide QJSA in pension plans
  • Also offers QPSA
  • No in-service withdrawals are allowed
    • Except for DEFINED BENEFIT PENSIONS PLANS for those over age 62
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6
Q

Profit sharing plans characteristics

A
  • Allow deferral of compensation and taxation until retirement
  • Not subject to minimum funding standards
  • Contributions must be “substantial and recurring”
  • Not limited in amount to invest in employer securities (100%)
  • Does not have to provide QPSA or QJSA
  • Can allow in-service withdrawals after two years if plan document permits
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7
Q

Defined benefit plans and characteristics

A
  • Plans include:
    • Defined benefit pension plan
    • Cash balance pension plan
  • Risk is assumed by employer (employer resonsiblity for investment growth and paying pension benefit)
  • Must contribute enough each year to the plan so it is property funded (must be done by actuary each year)
  • Commingled accounts rather than indivdiual accounts for employees
  • MUST HAVE PBGC insurance (unless firm has less than 25 employees)
  • Forfeitures must be allocated toward reducing plan costs
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8
Q

Defined contribution plans and characteristics

A
  • Can be pension plan (target benefit, money purchase) or any profit sharing plan
  • Investmnet risk is assumed by employee to manage assets
  • Employer contributions are LIMITED to 25% of covered compensation
    • Exceptions are CODA plans where employee can defer up to 100% of their compensation subject to deferral limits
  • Individual accounts for employees
  • Not subjec to PBGC
  • Forfeitures can be allocated to reducing plan costs or toward other participants
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9
Q

To be considered a qualified PENSION PLAN, what are the rules and requirements talked about?

A
  • Mandatory funding
  • In-service withdrawals
  • Life insurance
  • Employer securities
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10
Q

Pension plans - mandatory funding

A
  • Requires mandatory funding for ALL PENSION PLANS
    • Defined benefit
      • Requires actuary EVERY YEAR
      • Employer can only DEDUCT the amount required to sufficiently fund the pension pool
    • Defined contribuiton pension plan
      • Mandatory funding amount is included in plan document and must be made annually
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11
Q

Pension plans - In-service withdrawals

A
  • NONE ALLOWED
  • Exception:
    • Loans from pension plan, if allowed from plan document
    • Defined benefit pension plans only:
      • Allow for in-service distribution to participants age 62 and older
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12
Q

Pension plans - life insurance

A
  • May purchase life insurance as long as it is NOT a primary investment of the plan
  • Premiums paid by employer are TAXABLE TO EMPLOYEE
  • Must pass ONE of TWO tests in order to remain qualified status:
    • 25% test
    • 100-to-1 Ratio test
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13
Q

Pension plans - life insurance (25% test)

A
  • Depends on type of life insurance held:
    • Term/universal life held in plan:
      • Aggregate premiums paid for policy CANNOT exceed 25% of the employer’s contributions to the account
    • Whole life
      • Increases to 50% of employer contributions
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14
Q

Pension plans - life insurance (100-to-1 test)

A
  • Limits death benefit of life insurance purchased to 100 x the monthly accrued retirement benefit provided under the plan’s defined benefit formula
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15
Q

Pension plans - Employer Securities

A
  • Assets of a pension plan may be invested in employer securities with limitations:
    • Value of employer securities CANNOT exceed 10% of the value of the plan at the TIME OF PURCHASE
  • For defined contribution pension plans:
    • Employer must allow participants to diversify their holdings:
      • At least three different, nonemployer, investment options in the plan (usually cash equivalnets, fixed income, and equities)
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16
Q

Defined benefit pension plan characteristics

A
  • Includes defined benefit pension plan and cash balance pension plan
    • Actuary
      • Raises admin costs
    • Commingled accounts
      • Employees receive just statements of their accrued benefit
    • Investment risk
      • Employer bears all risk
    • Allocation of forfeitures
      • Tor reduce plan costs for employer (requried)
    • PBGC
      • Pays monthly benefit if plan is ever unfunded or underfunded
      • Professional practices (attorney, accountant, etc) with fewer than 25 participants are NOT COVERED
    • Credit for prior years’ service
      • Must be nondiscriminatory
    • Integration with Social Security
      • All plans are allowed for this
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17
Q

Defined benefit pension plans - integration with social security

A
  • Allows for a HIGHER contribution to those who make ABOVE the Social Security wage base
  • Two types of integration methods:
    • Excess
      • Available ONLY for defined benefit pension plan (not cash balance)
    • Offset
      • Available for ALL plans
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18
Q

Integration with SS - Excess Method

A
  • ONLY for defined benefit pension plan (not the cash balance)
  • Provides an excess benefit to those participants who earn more than the average SS wage base over the 35-year period PRIOR to retirement
  • Excess benefit is a percentage and is limited to the LESSER of:
    • 0.75% per year of service OR
    • The benefit percentage of earnigns below the covered compensation limit per year of service
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19
Q

Integration with SS - Offset Method

A
  • Available to all plans
  • Applies a benefit formula to all earnings and then reduces the benefit on the earnings below the average SS wage base
  • The reduction in benefit is limited to the LESSER of:
    • 0.75% per year of service up to 35 years
    • 50% of the overall benefit funding percentage per year of service
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20
Q

Defined benefit pension plans - Postives and negatives

A
  • Postiive
    • Benefiits older employees
    • Offset method is available
    • Credit for priors’ years service
  • Negative for employers
    • PBGC in required
    • Actuary is required
    • Employer bears investment risk
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21
Q

Defined benefit pension plan formulas

A

Unit Credit

Takes into account salary AND years of service x a percentage

years of service X avg of hightest 3 years pay X 1.5% = accrued benefit

Flat Amount

Everyone receives same benefit

Example: $6,000/year

Flat Percentage Amount

Avg of highest 3 years pay X 5% (for example)

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22
Q

Cash balance pension plans - some differing characteristics

A
  • Appears to the particpant as an individual account, however there is actually no separate account for each participiant.
    • Employee receives a statement with a hypothetical allocation and hypothetical earnings
  • SS integration is only with EXCESS METHOD
23
Q

Conversion from Cash Balance FROM Defined benefit

A
  • Requirements required desinged to protect older workers:
    • Accrued benefit under the new plan must be equal to or greater than that of any simlarly situated, younger employee.
    • Interest rate used to determine the interest credit on the new plan must NOT be greater than the market rate of return
    • New plan must provide 100% vesting AFTER THREE YEARS
24
Q

Defined Contribution Pension Plans - Characteristics

A
  • Have some characteristics of defined benefit pension plans and profit sharing plans
  • Actuary
    • Target benefit requires actuary ONLY at beginning of plan (no annual work is required)
    • Money purchase does NOT require actuary because annual contribution is predefined
  • Commingled Accounts
    • Individual investment accounts (employee selects investments)
  • Investment risk
    • Employee bears all investment risk
  • Allocation of forfeitures
    • Can be used to reduce future plan costs for employer or allocated to reamining particapnts’ accounts in nondiscrimnatory way
  • PBGC
    • Does not cover these
  • Credit for prior years service
    • None
25
Q

What does Social Security integration do?

A
  • Allows for a higher contribution to those who make ABOVE the SS wage base
26
Q

Understanding SS integration in a Defined Contribution Plan

A
  • Permitted disparity
    • Through SS integration, plan is allowed a disparity of contributions between HCE and NHCE (so contribution for HCE is increased by a certain rate)
  • Social Security Integration
    • Attemps to equalize the percentage of contributions for total retirement.
27
Q

Permitted Disparity Rules for Defined Contribution Plans

A
  • Permitted disparity is the LESSER of:
    • Base contribuiton percentage (whatever the employer contributes) OR
    • 5.7%
  • Example:
    • Employee receives 10% contribution from employer and makes 150k
      • 10% x 150k = 15,000
      • 5.7% x (150k - SS wage base) = $974
      • Total contribution permitted = 15,000 + 974
28
Q

Defined contributon positives/negatives

A
  • Positives
    • Less expensive than defined benefit plans
    • No annual actuary required
    • No employer risk for investments
    • NO PBGC insurance premiums
    • Can allocate forfeitures to particpants
  • Negatives
    • Cannot grant credit for piror years’ service
    • Cannot integrate with SS using offset method
29
Q

Money purchase pension plans characteristics

A
  • Defined contribution
  • Provides a contribution each year of a fixed percentage of employees’ compensation
  • No specific benefit guaranteed, although the contribuiton is guranteed
  • Separate accounts for particpants
  • Benefits younger particpants
  • Employer cannot deduct contributions more than 25% of total covered compensation paid
30
Q

Target Benfit pension plans characteristics

A
  • Is a type of money purchase plan
  • Contributions to each particpant are actuarially equivalent
    • Older participants will receive a larger contribution since they are closer to retirement
    • Younger will receive less of a contribution
  • Actuary is required for establishment of plan, but not after
  • Contribution based on the original plan document and funding formula
31
Q

Name the profit-sharing plans

A
  • Profit-sharing
  • 401k
  • Thrift
  • Age-based profit sharing
  • New comparability plans
  • Stock bonus
  • ESOP
32
Q

Profit sharing plans - Funding/Contributions

A
  • Employer is not obligated to make contributions
  • Contribution limit of 25% of covered compensation
  • Contribuitons are discretionary, but funding must be substantial and recurring
  • Contributions are not necessarily correlated with actual profit from company (they don’t need to contribute in high profit years and they could contribute in low profit years)
33
Q

Profit sharing plans - Deadline

A
  • Must establish qualifeid plans as late as the due date of the tax return (inlcuding extensions) for the year that the plan is to be adopted
  • Same time frame for funding the plan
  • For CODA plans;
    • Must be set up prior to start of the year so employees can be notified and have time to make elective deferrals
34
Q

Profit sharing plans - Forfeitures

A
  • Can be used to reduce empoyer contributions to plan OR reallocated to particpiants’ accounts
  • If employees ALREADY HAVE MAX CONTRIBUTION in account, they cannot be given this forfeiture amount
35
Q

Profit sharing plans - Distributions

A
  • Not allowed except for:
    • Hardship
    • Termination
    • Disability
    • Retirement
  • Can allow for in-service withdrawals after participant has completed TWO YEARS of service under the plan.
36
Q

Profit sharing plans - SS integration

A
  • Permitted disparity is allowed using the EXCESS METHOD
37
Q

Age-Based Profit Sharing Plans

A
  • Uses age and compensation for allocating contributions to employee’s account (rather than just compensation like other profit sharing plans)
  • Contributions are greater for older employees
38
Q

New Comparability Plans

A
  • Profit shraing plan
  • Bases contributions on the employee’s CLASSIFICATION in the company as defined by the plan
  • MORE expensive to administer because of the several nondiscrimination tests to be met
39
Q

CODA plans

A
  • Creates a contributory component (deferrals for employees)
  • Includes 401k plans, stock bonus plans, profit sharing plans)
40
Q

CODA - Eligiblity

A
  • To participate in a 401k:
    • Employee cannot be required to complete more than 1 year of service
    • Employees under 21 can be exluded (like other plans)
    • Plan MUST HAVE TWO ENTRANCE DATES PER YEAR
41
Q

Some key differences between Roth IRA and Roth 401(k)

A
  • Income Limits
    • None for ROTH 401K
  • Conversions from Traditional IRA
    • NO CONVERSIONS allowed for ROTH 401K
  • Loan availabliyt
    • YES for ROTH 401K
  • Qualified Distribuitons
    • Both must be held for at least 5 years, but qualified distributions differ from IRA and qualified plan rules
42
Q

Thrift Plans

A
  • These are CODA plans that allow employees to make AFTER TAX contributions
  • These contributions are usually made AFTER the elective deferral limit for the year has been met
43
Q

Stock Bonus Plans

A
  • Ideal for employers who want to create a profit sharing plan for employees BUT do NOT have the ability to contribute large amounts of cash.
  • Contributions are made in the form of employer stock
44
Q

Stock bonus plans - Requirements

A
  • Participants must have pass-thorugh voting rights on the employer stock held (full voting rights)
  • Participants have the right to demand that the employer repurchase the employer stock if stock is NOT publicly traded
  • Particpatns have the right to demand the stock be distriubted when requesting a distribuiton from the plan
  • Distribuions must begin WITHIN ONE YEAR of NRA, death, or disaiblity, OR WITHIN FIVE YEARS for any other type of employee termination
  • Distributions must be FULLY PAID WITHIN FIVE YEARS of the start of distribution
45
Q

Stock bonus plan - What happens if employer stock is publicly traded?

A
  • Must allow partiicpants to diversify the contributions in the plan
    • Meaning that they can sell the stock and diversify their investments
46
Q

Stock bonus plans - other features

A
  • Can add a CODA component
  • Same requirements as other profit sharing plans (eligilbity, coverage, vesting)
47
Q

Stock bonus plans - distribuitons

A
  • Can allow employee to receive cash insteaad of stock, if availalbe
  • IF an employee distributes stock IN KIND:
    • Employee can defer recognition of stock’s appreciated value until stock is sold (NUA benefit)
      • Must be distributed as LUMP SUM for this special recognition of income.
  • If cash equivlanet is slected, you lose NUA benefit
48
Q

Stock bonus plans - Pros

A
  • Business tax deduction = FMV of stock contributions
  • Everyone in corp has interest in company success
  • NUA benefit potential
49
Q

Stock bonus plans - Cons

A
  • Ownership is diluted (only a problem for closely held companies)
  • Repurchase option of employees could create cash flow issues for company
  • Non-diversified wealth and risk
50
Q

What is an ESOP

A
  • Employee stock owenership plan
  • Type of stock bonus plan that provides employees with ownership in the coporation WHILE ALSO PROVIDING OWNERS with TAX ADVANTAGES
  • Strucutre of ESOP beings with a trust, which controls the ESOP
    • Owner of coporation recieves a tax deduction for any stock that is contributed to the trust from the corporation.
    • The ESOP then allocates the stock to separate accounts for each employee participating.
  • Common element of ESOP is a leveraged ESOP
    • When the retirement plan trust borrows money from a bank to purchase the employer stock
    • Corporation repays loan through contributions to ESOP
    • These contributions (both interest and principal) are TAX DEDUCTIBLE
51
Q

ESOPs allow owners of a business to selll a portion (or all) of their interest in the corporation and defer the recongition of gain - What requirements are needed to be met to qualify for this?

A
  • ESOP must own at least 30% of the corporation’s stock immediately after the inital sale to the ESOP
  • Owner (seller) must reinvest the proceeds of the sale into qualified replacement securities WITHIN 12 months of sale
    • These replacement securities cannot be sold wtihin THREE YEARS of reinvestment
    • Qualified replacemetn securities include reinvestment in:
      • Domestic corporaiton including:
        • Stocks, bonds, debentures, warrants, stock in S corp
      • Qualified replacement securities must receive NO MORE than 25% of their income from passive investments
  • Corporation establising the ESOP must have NO CLASS OF STOCK that is tradable on an established securities exchange market (publicly traded)
  • Sellers, relatives of sllers, of 25% shareholders in the corporation cannot receive stock through the ESOP
  • ESOP cannot sell stock acquired through the rollover transaction for THREE YEARS
  • Stock sold to the ESOP must be common stock or preferred stock and must have been owned by seller for THREE YEARS prior to sale to ESOP
52
Q

ESOP - Other requierments

A
  • Participants have same voting rights
  • Employer contributions to ESOPs are deductible like any other profit sharing plan
  • ESOP can hold 100% of corporate stock
  • Participant must be offered diversification within 90 days after close of the plan year
  • NOT ELIGIBLE For SS integration (stock bonus plans are)
53
Q

ESOP - Pros

A
  • Business owners may sell company and create diversified portfolio w/o recognzing capital gains
  • Business tax deduction = FMV of stock contributions
  • Compnay can borrow against stock to make leveraged ESOP
  • Everyone in company has interest in comapny success
  • NUA potential
  • Employees can sell stock to company after certain requiremetns are met
54
Q

ESOP - Cons

A
  • Diluted ownership (problem for closely held corporations)
  • Repurchase option of employees could create cash flow problem for corporation
  • Costs of regular appraisals of stock value are required, increasing plan costs
  • Non-diversified wealth and risk
  • Non-liquid stock
  • Value of non-traded stock is based on appraisal

Retirement Savings and Income Planning (11 decks)

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