Bryant - Course 5. Retirement Planning & Employee Benefits. 8. Plan Selection for Businesses Flashcards
It is said that the ability to think and plan for the future distinguishes human beings from other species. It may also distinguish an individual’s successful retirement from an unsuccessful one. A successful employer, who wishes to maximize the profits of his or her organization and have a productive workforce that is happy, needs to choose the right retirement plans for its employees.
The employer will have personal objectives with regard to cost and tax benefits in mind while framing the plans. Financial planners gather the information about the existing plans in the organization and will devise the new plan based on the objectives of the employer. The critical success factor of any organization today is its ability to recruit, retain, reward and develop employees.
The Plan Selection for Businesses module, which should take approximately four hours to complete, will explain the personal and business objectives of the owners of a business.
Upon completion of this module, you should be able to:
* Explain the tax considerations of retirement plans from a business owner’s perspective,
* List the capital needs at retirement and at death,
* Explain the role of a plan,
* Differentiate between qualified and nonqualified plans,
* Explain the need for qualified plans,
* Distinguish between qualified plans and cash, and
* Match the objective of the employer with the right plans.
Module Overview
- Proprietorships and partnerships have one significant difference from corporations for benefit plan purposes.
- In proprietorships and partnerships, the owners are not technically employees of the business.
- By contrast, in a corporation an owner, even a 100% shareholder, who works in the business, is technically an employee of the corporation.
- In the case of S corporations, the Internal Revenue Code (IRC) requires the shareholder employees, those holding more than two percent of the S corporation’s stock, to be treated as partners for most employee benefit purposes.
The plan objectives of a retirement plan need to match the employer objectives. Plans are designed using design features to maximize benefits to the highly compensated. They are also used as a valuable saving medium that provides adequate replacement income for all employees. An employer may also use a plan to encourage retirement, minimize turnover and increase productivity, while maximizing employer contribution flexibility.
To ensure that you have a solid understanding of plan selection for businesses, the following lessons will be covered in this module:
* Owners’ Personal Objectives
* Business Objectives
Section 1 - Owner’s Personal Objectives
When a plan attempts to cover business owners, some differences may arise. Many sections of the code providing favorable tax treatment of employee benefits apply only to employees. Thus, the benefits package for these organizations involves less favorable benefits for owners than if the organization was incorporated. If the situation is seriously adverse to the owners, the planner might even consider incorporating the organization.
Proprietorships, partnerships, and S corporations can have benefit plans for their employees that are exactly the same as those of regular or “C” corporations. Deductibility of benefit costs is the same as the employer, and tax treatment to these regular employees is also the same.
Qualified retirement plans are a very significant exception to the unfavorable treatment of business owners in these organizations. Qualified plans can cover owners of unincorporated businesses on much the same basis as regular employees. These differences are so small that it seldom pays to incorporate a business for qualified plan benefits alone.
To ensure that you have a solid understanding of the owner’s personal objectives, the following topics will be covered in this lesson:
* Tax Considerations
* Capital Needs at Retirement
* Capital Needs at Death
* Upon completion of this lesson, you should be able to:
* Explain the tax considerations for a business owner,
* Outline the capital needs at retirement, and
* Specify the capital needs at death.
What is the unique feature of a Keogh Plan when compared with qualified plans adopted by corporations?
* Keogh Plan’s contribution on behalf of the owner is based on compensation.
* Keogh Plan’s contribution on behalf of the owner is based on investment income.
* Keogh Plan’s contribution on behalf of the owner is based on contributions.
* Keogh Plan’s contribution on behalf of the owner is based on earned income.
Keogh Plan’s contribution on behalf of the owner is based on earned income.
* The unique feature of a Keogh plan, when compared with qualified plans adopted by corporations, is that the Keogh plan’s contribution on behalf of the owner is based on earned income as opposed to compensation. Earned income is defined as the self-employed individual’s net income from business after all deductions, including the deduction for the Keogh Plan contributions.
Section 2 - Business Objectives
The business objectives of the employer are of prime importance while devising a retirement plan. In order to design a pension plan for a business, three broad steps can be followed.
The first step consists of gathering the relevant facts. In this step the important factual information is gathered by conducting an employee census. In the census, a list of all employees with their compensation levels, ages and years of service for the employer is found. The existing and past pension programs maintained by the employer are studied.
The second step consists of identification of employer objectives. In addition to factual information, the retirement planner must develop with the client a list of objectives that can be promoted by a retirement plan and their priorities to the employer.
The third step is to choose plan features, which promote the employer objectives.
To ensure that you have a solid understanding of business objectives, the following topics will be covered in this lesson:
* What Can a Plan Do for the Employer?
* Qualified Versus Nonqualified
* Qualified Plans
* Qualified Plans Versus Cash
* Matching Employer Objectives with Right Plan
Upon completion of this lesson, you should be able to:
* Explain what a plan can do for the employer,
* Distinguish between qualified and nonqualified plans,
* Describe the need for qualified plans,
* Differentiate between qualified plans and cash, and
* Match employer objectives with the right plan.
PA: Life insurance & annuities are two products that grow tax deferred
What is the important important thing a Plan Do for the Employer?
The most fundamental reason for retirement plans is to help employees with retirement savings. Most employees, even highly compensated employees, find personal saving difficult. It is difficult because the current tax system and economy are oriented toward consumption rather than saving.
For example, the federal income tax system imposes tax on income from savings, even if it is not used for consumption, with only several major exceptions:
Deferral of tax on capital gains until realized,
Limited exclusion of gain on the sale of a personal residence,
Tax deferral of gains in qualified plans, IRA’s, Section 529 College Savings plans, Coverdale Plans for education as well as annuity and life insurance contracts.
In other words, a qualified retirement plan or other tax advantaged plan is one of only several options our government offers to encourage savings. The benefits of a retirement plan are available only if an employer adopts the plan.
Practitioner Advice: Life insurance and annuities are two products that enjoy tax deferred growth as allowed by the tax code.
Which of the following are ways savings are encouraged through the tax system? Click all that apply.
* Deferral on tax on savings accounts
* Potential exclusion of a base amount of the capital gain of the sale of a primary residencence
* Deferral of tax on capital gain recognition on securities until sold
* Tax free accumulation of interest on corporate bonds
* Favorable tax treatment for Roth IRA assets
Potential exclusion of a base amount of the capital gain of the sale of a primary residencence
Deferral of tax on capital gain recognition on securities until sold
Favorable tax treatment for Roth IRA assets
Three ways saving is encouraged through the tax system are:
* Deferral of tax on capital gains until realized
* Potential exclusion of a base amount of the capital gain of the sale of residence
* Deferral of tax and other benefits for qualified retirement plans and other tax advantaged plans
In a defined contribution plan, there is one main account where all participant money is invested. State True or False.
* False
* True
False
- In a defined contribution plan, the employer establishes and maintains an individual account for each plan participant.
- When the participant becomes eligible to receive benefit payments, the benefit is based on the total amount in the participant’s account.
Describe Money Purchase Plan
Under a money purchase plan, the employer is required to contribute a fixed and stated amount to the plan. The maximum deductible employer contribution may be up to 25% of aggregate covered compensation. The mandatory nature of the Money Purchase plan causes most employers to avoid these plans since they can contribute just as much to a Profit Sharing plan without the mandatory contribution requirement.
Practitioner Advice:
* Because profit-sharing plans also share the 25% limit, most employers who have maintained money purchase plans have replaced those plans with a profit-sharing plan.
* One of the only circumstances still favoring money purchase plans exists when a collective bargaining agreement with a union requires a plan. The union will usually want to see a money purchase plan as the employer will be subject to the minimum funding standard.
Match the corresponding types of plans with the descriptions:
Money Purchase
Target Benefit
Profit Sharing
Defined Benefit
* In these plans, employer can choose not to contribute.
* A defined contribution plan where the participant’s age at plan entry is considered when determining the contribution percentage.
* One of the simplest of all retirement plans. The employer must contribute each year to the plan.
These plans are funded actuarially. The employer assumes the investment risk.
- Money Purchase - One of the simplest of all retirement plans. The employer must contribute each year to the plan.
- Target Benefit - A defined contribution plan where the participant’s age at plan entry is considered when determining the contribution percentage.
- Profit Sharing - In these plans, employer can choose not to contribute.
- Defined Benefit - These plans are funded actuarially. The employer assumes the investment risk.
Which of the following are characteristics of employees who value immediate cash? Click all that apply.
* Younger employees
* Long-term employees
* Highly compensated employees
* Short-term employees
Younger employees
Short-term employees
* Employees who value immediate cash are usually younger employees who do not expect to stay with the employer long. In addition, they are often lower-paid employees as well.
Exam Tip: All these assumptions must be reasonable.
Describe Defined Benefit Plans
Exam Tip: All these assumptions must be reasonable.
Defined benefit plans typically provide the maximum possible proportionate benefits for key employees when key employees, as a group, are older than rank and file employees. This age distribution exists in the majority of small businesses.
A defined contribution plan restricts the annual additions limit for each participant to the lesser of 1) 100% of compensation or 2) $66,000 (2023).
A defined benefit plan has no such dollar limit on the amount of contributions. Instead, the projected benefit, not the contribution,** is subject to a limit of the lesser of 100% of the employee’s high three-year average compensation or $265,000 (2023)**.
Funding the maximum annual benefit for a younger employee generally requires a deductible employer contribution that is less than the $66,000 (2023) defined contribution limit, while for an employee who enters the plan at an old age, the deductible contribution for that employee may be more than $66,000 annually. For a given set of actuarial assumptions, there is a crossover age at which the defined benefit plan is more favorable to adopt. The crossover age is somewhere between 45 and 50 approximately, depending on the actuarial method and assumptions used in the defined benefit plan.
Defined benefit plans can be made even more favorable to key employees by appropriate choices of:
* Actuarial assumptions,
* Retirement age and late retirement provisions,
* Form of benefits, and
* Level of Social Security integration.
Exam Tip: All these assumptions must be reasonable.
Exam: Who assumes investment risk w/ a Cash Balance Pension? EMPLOYER
Describe Cash Balance Plans
Exam Tip: Who assumes the investment risk with a Cash Balance Pension plan?
The EMPLOYER!
Cash balance plans are a type of defined benefit plan that operates very much like a defined contribution plan of the money purchase type.
The employer guarantees the principal and interest rate, so the employee assumes no investment risk.
However, cash balance plans tend to provide greater benefits to younger employees and those with shorter service, as compared to other defined benefit plans.
Exam Tip: Who assumes the investment risk with a Cash Balance Pension plan?
The EMPLOYER!
Exam: Can co make a contr to profit sharing plan in yr w/o profit? yes!
Describe Profit Sharing Plan
Although a profit sharing plan is not technically required to make contributions out of profits, most plans are designed to do so.
The profit sharing element provides extra bonus compensation to participating employees when the business does well, which also acts as an incentive.
Exam Tip: Can a company make a contribution to a profit sharing plan in a year that does not have a profit? Absolutely! A company is able to borrow the necessary contribution from a bank.
PA: ESOP/stock bonus plan protect 55, >10yr entitle election 2 diversify
Describe the ESOP/Stock Bonus Plan
Practitioner Advice: The ESOP/stock bonus plan can be a very risky situation because of lack of diversification. One protective feature for ESOP participants is the requirement that those who have reached 55 and who have at least 10 years of participation in the plan be entitled to an annual election to diversify investments in their accounts.
A plan providing that the employee’s account balance is partially or totally invested in stock of the employer has substantial incentive features, paralleling the equity-based compensation arrangements often used for executives. The participant’s account goes up and down in value with company stock. So its value depends almost entirely on good performance by the business. If the employee believes that his or her performance has an effect on business results, the ESOP and stock bonus plans can be a powerful performance incentive.
Practitioner Advice: The ESOP/stock bonus plan can be a very risky situation because of lack of diversification. One protective feature for ESOP participants is the requirement that those who have reached 55 and who have at least 10 years of participation in the plan be entitled to an annual election to diversify investments in their accounts.
