Defined Contribution Plans Flashcards by Jeff Pratt

What is a defined contribution plan?

Each employee has an individual count in the plan and the plan benefit consist of the amount of accumulated in the account at retirement or termination employee bears investment risk and the earnings are tax deferred

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Define contribution plans

Annual additions to each employees account are limited to the lesser of what?

100% of compensation or

$69,000 (2024)

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Define contribution plans

Tax deductible employer contributions are limited to what ?

25% of aggregate covered compensation

The rule applies to the companies, total countable compensation for all covered employees and not of an individual employees compensation

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Defined contribution plans

Has generous vesting schedules what are they?

3 year cliff or

2 to 6 year graded

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Define contribution plans

What are the defined contribution plans?

Money purchase plans

Profit sharing plans

Stock bonus plans, and employees stock ownership plans

401(k) plans

Roth 401(k) plans

Simple 401(k)

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Money purchase pension plans

What is it?

Qualified employer pension retirement plan

Employer makes annual mandatory contributions to each employees account under a non-discriminatory contribution formula

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Money purchase plan

Does it favor older or younger employees?

Younger

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Money purchase pension plans

What are some of the advantages?

Easy to administer

May be integrated with Social Security

Known funding cost

May include voluntary or mandatory employee contributions

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Money purchase pension plans

What are some of the disadvantages?

Mandatory funding

No mechanism to influence, employee retirement, and turnover decisions

Failure to make mandatory employer contributions results in penalty

Less employer flexibility than profit sharing plans

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Money Purchase Pension Plans

What is the maximum contribution allowed into employers securities?

10%

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Money purchase pension plans

When is it appropriate?

Employer, once qualified retirement plan that is simple to administer an easy to explain and does not mind Mandatory funding.

Self-employed person has no employees , does not mind mandatory funding

Employees are willing to accept the investment risk

Some degree of retirement income security is desired

Best with mature businesses with predictable cash flow

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Profit sharing plans

What is it?

A qualified defined contribution plan

Employer, contributions and employee contributions are permitted

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Profit sharing plan

Are in-service withdrawals allowed?

Yes

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Profit-sharing plans

What vesting schedule must you use?

Accelerated vesting schedules

3 year cliff and 2-6 year graded vesting

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Profit sharing plan

What are the contribution limits?

May not exceed 25% of total participant includable compensation

Individual employee includable compensation limited to $345,000

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Profit sharing plans

They are appropriate in the following circumstances

Employers ability to contribute varies annually

Employer wants qualified plan with incentive

Employees are relatively young

Employees can bear investment risk

Employer wants to supplement existing defined benefit pension plan

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Stock bonus plans, and employee stock ownership plans (ESOPs)

How are distributions to the plan usually made

Made in the form of employer stock

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Stock bonus plans, and employees stock ownership plans (ESOPs)

Do the participants of the plan have voting rights on the stock owned?

Yes

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Stock bonus plans, and employee stock ownership plans (ESOPs)

Can employees use the net unrealized appreciation (NUA)?

If elected at the time of distribution

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Stock bonus plans and employees ownership plans (ESOPs)

What are the disadvantages?

Non-diversified portfolio

Appraisal cost to the employer

Dilation of ownership

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Stock bonus plans, and employees stock ownership plans (ESOPs)

What is the difference between a stock bonus plan and an ESOP?

Only the ESOP may borrow funds to purchase stock (LESOP)

ESOP may not be integrated with Social Security

401(k)

What is a brief description?

Qualified, profit-sharing or stock bonus plan

Employees make elective contributions

Contributions can be pretax or after tax

Can be funded entirely by employee contributions

401(k)

When are they appropriate?

Employer:
Wants a qualified plan with minimal cost

Wants employee deferrals to be the primary source of funding

Wants to supplement another existing retirement plan

Employees:
Want options for saving

Are young

Can accept investment risk

401(k)

What are the disadvantages?

Accounts at retirement may not be adequate

Max elective deferral is $23,000 with $7500 catch up for 50+

Employer deduction max 25% total covered compensation of participants

Additional non-discrimination test: ADP/ACP

401(k) What are and how are the elected deferrals treated?

Partial for total funding by employee, elected referrals Elective referrals / earnings 100% vested Participants in multiple plans must aggregate elected deferrals in applying annual limit exceptions for 457 plans

401(k) Employer contributions

Must use a formula or discretionary matching Her purely discretionary Qualified non-elective Reallocated for forfeitures

Roth 401(k) What is the plan overview

Used with traditional section 401(k) plans After tax elective deferrals Tax-free qualified distributions Employer contributions made to regular section 401(k) account Roth 401K balances tracked separately

Roth 401k Plan Contibutions

Max deferrals $23,000 Age 50+ $7500 catch up Contributions in after tax dollars Unlike a Roth IRA , no contribution phase out based on MAGI Deferrals Included in ADP calculation

Roth 401k Plans distributions

Basis - tax-free Earnings - tax-free if distribution is a qualified distribution Five year rule Age 59 1/2, death or disability No, first time homebuyer distribution exemption RMD rules apply (do not for a ROTH IRA) Nonqualified distributions Pro Rata Treatment (non taxable and taxable) Different ordering rules

Roth 401k Are you allowed to do an in plan Roth conversion?

Yes, if plan provisions allow

Roth 401k How are in plan Roth Conversions handled?

No early distribution penalty Regular Roth conversion tax treatment No 20% withholding Conversion tax payable from other funds

Simple 401(k) Testing and contributions

Avoids ADP / ACP testing and top heavy rules Employee Contributions: Max elective deferrals, $16,000 plus $3500 50+ catch ups Employer required contributions: matching up to 3% comp OR Nonelective 2% comp for all eligible employees, 100% vested immediately.

Self Employed (Keogh) Plan Description

Self Employed individuals Schedule C net earned income Types of Keogh plans are profit sharing plan with a 401(k), and a money purchase pension plan

What are the hybrid plans

Target benefit pension plan Age weighted profit-sharing plan New comparability plan

What are the applications for hybrid plans?

Alternative to define benefit pension plans Terminate existing defined benefit pension plan Closely held businesses with many older key employees

What is a Target Benefit Pension Plan?

Define contribution plan Each employee has their own account and Bears investment risk Employer makes mandatory contributions Subject to annual edition limit of $69,000 Favors older participants - larger contributions made for those closer to retirement age

What is an age weighted profit sharing plan?

Define contribution profit sharing plan Proportional allocations, age adjustment Participants accrual rates, older employees, receive a larger contribution because they are closer to retirement

What is the new comparability plan?

Define contribution plan Groups or classes of employees Disparity in owners ages Employee classifications Must pass nondiscrimination test Must allocate contributions if plan fails

Social Security Intergation What is it?

SS integration allows the employer to make large contributions or provide greater benefits to higher income earners Most qualified plans and SEP plans can integrate contributions / benefits with Social Security

Social Security integration Who determines the integration level?

Usually determined by the employer, but usually equal to the Social Security wage base $168,600 for 2024

Social Security integration What to method of integration do find benefit plans allow?

Excess method - plan provides additional benefits / contributions for earnings above the integration level Offset method - plan reduces benefits for earnings below the integration level

Social Security integration What is the maximum permitted disparity in need to find benefit pension plan integration

3/4 of 1% or 75 basis points multiplied by years of service, up to 35 years Maximum increase in benefits for earnings above a covered compensation level equals 26.25% (3/4 x .01 x 35)

Social security integration Defined contribution plans only allow what method of integration

Excess method

Social Security integration Allows higher contributions above the integration level. What is the following terminology used in the access method? Integration level , base percentage, and excess percentage

Integration level - the level of compensation at which point contributions calculations change Base percentage - contribution level below the integration level Excess percentage - contribution level above the integration level

Social Security integration What is the excess percentage?

It is the maximum permitted disparity Is limited to the lesser of : Two times the base percentage or Base percentage +5.7%

Social Security integration Under the excess method, can the integration level be lower than the Social Security wage base

Yes, affects maximum permitted disparity. The employer will set the integration level based on the employees senses.

Social Security integration A few plans and contribution types cannot be integrated with Social Security, which is the most important for you to remember ?

ESOP cannot be integrated with Social Security

Choosing the right retirement plan Clue #1 consistency, and strength of business income If the business has fluctuating cash flows , you should not recommend any type of pension plan (required annual contributions) you should instead recommend a profit-sharing plan of some type. What are possible recommendations?

Traditional profit-sharing plan New comparability profit-sharing plan ESOP or stock bonus plan (if using company stock to make contributions)

Choosing the Right Retirement Plan Clue #2: Age of Owners You should assume the business owner is your client and that the owner wants to maximize their own contributions and minimize employee contributions unless otherwise stated. In this case, if the owner is significantly older than most employees, you should recommend a retirement plan that shifts contributions to favor older employees, favoring the owner. What are the possible recommendations?

Traditional defined benefit plan (only if profits are strong and consistent) Age weighted profit-sharing plan Target benefit pension plan

Choosing the right retirement plan Clue #3: business owner wants to make large contributions to maximize tax benefit If the business has large profits and the owner wishes to make a large contributions, you will want to first consider a defined benefit plan because the annual addition limit will not apply. However, remember that the income of the business should be consistent before recommending a defined benefit plan so what are possible recommendations?

Traditional defined benefit plan Cash balance pension plan

Choosing the right retirement plan Clue #4: business owner wants employees to take responsibility for retirement savings If the owner wants employees to be responsible for saving for their own retirement, a CODA plan would be an appropriate recommendation because most contributions will usually be made by the employees. What are possible recommendations?

Traditional / Roth 401k Simple 401k / Simple IRA