Types of retirement plans Flashcards
What are the differences between non-qualified and qualified plans?
Non-qualified, deferred compensation plans:
- May discriminate
- Exempt from most ERISA requirements
- No employer tax deductions for contributions
- Plan earnings taxable to employer
- Distributions taxable at ordinary tax rates
Qualified plan:
- May not discriminate
- ERISA requirements
- Tax deduction for contribution
- Earnings accrue tax deferred
Distributions taxable at ordinary tax rates, exception of 10 year averaging NUA under stock Bonus, ESOPs and 401ks
What are the defined contribution plans?
- Money purchase
- Profit sharing 401(k)
- Target benefit
- Stock bonus / ESOP
- Profit sharing
What is a money purchase plan?
- Follows a benefit formula requiring an annual employer contribution flat percentage of each eligible employee’s compensation
- Employer can only deduct up to 25% of total plan compensation
- Employer wants a stable workforce
- Simple to administer and explain
- Good for employees that are relatively young and well paid
- Employer needs stable cash flow contributions are mandatory.
What are the maximum contribution limits that an employee can receive for defined contribution plans?
Lesser of 100% of salary or $69,000 (2024)
Only the first $345,000 (2024) of each employees compensation can be taken into account
What is a target benefit pension plan?
Includes features associated with a defined benefit plan, such as benefits, older employees, fixed mandatory contributions, actuary determines initial contribution level
Provision shared with defined contribution plans: maximum contribution lesser of 100% of compensation or $69,000, retirement benefit is account balance, employee assumes investment risk, no annual actuarial, forfeitures may be real allocated
Account balance at retirement may be lower or higher than the Target due to the investment performance
Used by an employer that wants an alternative to a defined benefit plan that provides adequate retirement to older employees with the lower cost and simplicity of a defined contribution plan
What is a profit-sharing plan?
Qualified defined contribution plan featuring flexible, employer contribution provisions up to 25% of compensation
Employers contribution each year can be discretionary or nothing at all not mandatory however contributions must be substantial and reoccurring too many years go by or two little dollars are contributed IRS could retroactively disqualify the plan terminate it.
Each employee has an individual account
Selecting a profit sharing plan: employers’s profit margin or financial stability varies year to year, employer adopts a qualified plan with an incentive feature to motivate employees to make a company profitable
Employees are young well paid
What is a 401(k) plan?
Also known as a CODA
Provision added to a qualified profit, sharing or stock bonus plan
Deferral subject to FICA and FUTA taxes, but not federal
Limit on employee elected referrals is $23,000 (2024)
Ketchup contributions of $7500 50 and older
Why select a 401(k) plan? : Employer wants to provide a qualified retirement plan can only afford minimal extra expense beyond existing salary and benefit cost employees want to increase their savings on a tax deductible basis.
Deferral amount can also be supplemented by direct employer contributions up to the lesser of 100% of compensation or $69,000 (2024)
What is a solo 401(k)?
Not subject to coverage testing, and non-discrimination rules necessary for the typical 401(k) plan
Allows two different contributions: elective deferral up to $23,000 plus employer contribution with a cap of $69,000. Catch up contributions 7500.
Permitted when the only participants are the owner and spouse or two partners
Also known as a Uni 401(k).
What is a safe Harbour 401(k)?
Satisfies non-discrimination test
Statutory safe Harbor contribution using a match is a dollar for dollar on the first 3% of employee referrals and a .50% are the next 2% employee deferral. 4% if employee defers 5% of compensation.
If the employer chooses the non-elective referral method, the employer must contribute 3% of all eligible employees compensation, regardless of whether the employee is deferring
Employer contributions are immediately vested
Exempt from top heavy rules
How do stock bonus plans and employee stock ownership (ESOP) differ from traditional profit, sharing plans?
Stock bonus plan may invest plan assets in employer stock, ESOP must invest primarily in employer stock
Counter stated in shares of employer stock
Benefits, distributor, and employer stock
Employers may deduct dividends with respect to stock held an ESOP
When does it make sense to select a stock bonus plan or an ESOP?
Wants to broaden ownership of its stock to create a market for it, provide liquidy, business continuity
Provide its employees tax advantage means to acquire company stock
Wants workers to fill a sense of ownership
Unrealized appreciation NUA, may not be taxed to the employee at the receipt of distributions from the plan
Can I stock bonus plan or an ESOP? Borrow money from a bank or other financial institution?
ESOP changes the name to a LESOP
What is the ESOP diversification?
Age 55 or older 10 years of participation right to diversify to total of 50% of account balance
Must offer at least three investment alternatives or distribute, cash or certificates to the participant
What is a new comparability plan?
Contribution percentage formula for one category of participants is greater than the contribution percentage for other categories of participants. Tested under cross testing rules.
What is cross testing?
Except ESOPs
Measures define contribution plans for non-discrimination on the basis of benefits and define benefit plans are tested on the basis of contributions
cross testing generally results in higher contribution rate for older employees cross tested plans are sometimes referred to as age weighted
Cross tested plan does not apply a fixed age weighted formula, designed to provide maximum benefits to highly compensated. Employees benefits, for other employees are designed to provide the minimum required under non-discrimination regulations.
What is a traditional defined benefit plans?
Guarantees a specified benefit at retirement
Define benefit and cash balance plans are required to carry PBGC insurance
When does a defined benefit plan makes sense for an employer?
Maximize plan contributions to older employees
Older controlling employee wants to maximize tax deferred retirement savings for own benefit
What is the section 415 limit for defined benefit plans?
Maximum limit on the projected annual benefit
Benefit beginning at age 65 is the lesser of 275,000 (2024) or 100% of the participants compensation averaged over his or her three highest earning consecutive years
Not required to reduce benefits to a participant who retires as early as age 62
What are the formulas used to determine define benefit projected annual benefits?
Unit benefit formula:
Most frequently used
Also known as percentage of earnings per year of service formula
Factors both service and salary and determining the participants pension benefit
(% of earnings x number of years) x average annual compensation.
Final average method:
Earnings are averaged over a number of years usually 3 to 5 years prior to retirement , better matched to income at retirement. Only the first $345,000. (2024) of compensation is taken into consideration.
Pass service credits:
Defined benefit and cash balance plans may allow credits for past service
What is a cash balance pension plan?
Define benefit plan
Annual employer contributions at a specified rate each plan participant has an individual account
Employer guarantees contribution level and a minimum rate of return
Account balance at retirement will be a new authorized to provide Sam’s retirement benefit
Assets earn a higher return than guaranteed contributions are reduced
Assets earn a lower return than guaranteed contributions are increased
Disadvantage to older employees
Why would you select a cash balance plan?
Less expensive simpler define benefit plan
May allow for pass service credits
What is a 412(I) plan?
Define benefit plan funded with insurance products, such as life insurance and annuities
Insurance company actually determines the actual contribution due
When would an employer want to use a 412(I)?
Employers that have some need for life insurance
Allows for a large contribution, but plan return typically lower than other defined benefit plans
What must be done to forfeitures in a defined benefit plan and a cash balance plan?
Must reduce plan cost or contributions
Money purchase plan forfeitures may be allocated to what?
Employee account balance balances
Forfeitures in a profit-sharing plan are normally allocated to what?
Plan participants
What are pension plans?
Define benefit plans
Cash balance plans
Money purchase plans
Target benefit plans
