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Course 5: Retirement Savings and Income Planning > Module 3: Profit-Sharing and Other Defined Contribution Plans > Flashcards

Module 3: Profit-Sharing and Other Defined Contribution Plans Flashcards

1
Q

What are the features of a traditional profit-sharing plan?

A

It is a qualified defined contribution plan featuring a flexible, discretionary employer contribution provision

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2
Q

Where do the traditional profit-sharing contributions come from?

A

Discretionary contributions will typically come from profits, but are not strictly tied to them. They can make contributions even if there were no profits that year, in that case the contributions would come from retained earnings or current cash flow.

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3
Q

Substantial and Recurring Basis

A

For a profit-sharing plan to remain qualified, they must contribute in three of every five years.

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4
Q

How are contributions allocated for traditional profit-sharing plans?

A

Most common formula provides the contributions to be allocated to individual participant accounts on a pro rata basis determined by a given participant’s covered compensation in relation to the aggregate covered compensation of all participants.

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5
Q

In-Service Distributions

A

This is a major advantage of any profit-sharing plan, and the employer makes the decision on whether or not to include in-service withdrawals.

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6
Q

What are the rules for an allowable In-Service Distribution?

A
  • Hardship Withdrawals

- Post 59.5 withdrawals

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7
Q

Hardship Withdrawal Tests

A
  • Financial Needs Test

- Resources Test

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8
Q

Financial Needs Test

A

The hardship must be due to an immediate and heavy financial need of the participant-employee

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9
Q

Resources Test

A

The participant must not have other financial sources sufficient to satisfy the need

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10
Q

In addition to the hardship withdrawal tests, money may only be withdrawn for the following reasons:

A
  • Payment of unreimbursed medical expenses or funeral costs
  • Disasters declared by the federal government
  • Purchase of a primary residence
  • Payment of higher education expenses for the participant, spouse or dependent children
  • Payment necessary to prevent foreclosure on the participant’s primary residence
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11
Q

What is the taxability of hardship withdrawals?

A

All hardship withdrawals will be taxable and a 10% early withdrawal penalty will apply for all distributions except for deductible unreimbursed medical expenses (above 10% of AGI).

But Roth money inside the plan is neither taxed nor penalized

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12
Q

When should you use a profit-sharing plan?

A
  • An employer’s profits, or cash flow, fluctuate year to year
  • wants an incentive feature in their qualified plan
  • a majority of employees are young
  • employees are willing to accept a degree of investment risk in their individual accounts
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13
Q

Age-Based Profit-Sharing Plan

A

Profit-sharing plan in which allocations to participants are made in proportion to the participant’s age-adjusted compensation.

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14
Q

Cross-tested Plan

A

compliance with nondiscrimination rules is tested in accordance with benefits rather than contributions.

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15
Q

How do you adjust compensation on an age-basis?

A

Multiply the participant’s actual compensation by a discount factor based on the participant’s age and the interest rate elected by the plan sponsor.

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16
Q

When is an age-based profit-sharing plan most appropriate

A

When the business owner is significantly older than most of the employees and wishes to skew the annual contribution on his behalf without violating the nondiscrimination rules

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17
Q

New Comparability Plan

A

type of cross-tested profit-sharing retirement plan in which the employee-participants are divided into groups or classes.

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18
Q

What are some common group classifications for New Comparability Plans?

A

job category, age, or years of service

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19
Q

Two minimum gateway tests for the New Comparability Plan

A
  1. Each non-HCE must receive an allocation of at least 5% of the benefits
  2. If the plan is less than 5% then the benefits must be at least 1/3 of the highest allocation rate under the plan.
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20
Q

Stock Bonus Plan

A

Type of profit-sharing plan where the employer contributions and benefits distributed form the plan are generally made in the form of employer stock, not in cash.

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21
Q

Net Unrealized Appreciation

A
  • a major employee tax advantage of a stock bonus plan
  • retirees are not taxed on the full FMV of employer stock when it is distributed, instead it’s taxed as LTCG when the participant or beneficiary subsequently sells the stock.
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22
Q

How to receive NUA

A

The departing worker must elect to receive the stock in shares instead of cash
- Shares received cannot be rolled over

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23
Q

NUA Taxability

A
  • when distributed, taxed at ordinary income for the amount that is equal to the value when the stock was contributed
  • This is the tax basis which is recovered tax free as a return of basis upon the sale of the stock from the person’s normal brokerage account.
  • Any further appreciation of the stock subsequent to the time of the lump-sum is given LT or ST CG treatment, but
  • the nua portion is always given LTCG treatment
24
Q

Employee Stock Ownership Plan

A

a type of stock bonus plan in which individual participant accounts are invested primarily in employer stock.

25
Q

Leveraged ESOP (LESOP)

A

This is when there is money borrowed in the name of the ESOP plan

26
Q

How does the leveraged ESOP transaction work?

A
  • employer stock is pledged as collateral for the loan secured in the name of the ESOP
  • with the cash from the sale of the stock, the employer makes a cash contribution to the ESOP
  • A market is created for employer stock that helps improve the marketability of the stock for existing shareholders
27
Q

When is a ESOP appropriate?

A
  • employer wishes to make the employees the owners of the business through a tax-advantaged means at a relatively low cost.
  • the employer wishes to provide an advantageous vehicle for the company to borrow money for business needs such as expansion
  • the owner of the biz wants to engage in estate and financial planning that creates a market for the stock.
28
Q

What are the four types of 401(k) plans?

A
  • traditional Section 401(k) plans
  • Safe Harbor 401k plans
  • SIMPLE 401k plans
  • Roth 401k plans
29
Q

Traditional 401k plan (CODA)

A

A qualified profit-sharing or stock bonus plan under which plan particpants have an option to contribute money to the plan on a pretax basis or receive taxable cash compensation.

30
Q

How are traditional IRA elective deferrals taxed?

A

They do not get taxed at the income tax rate but they are still subject to FICA and FUTA taxation.

31
Q

What is included in ‘payroll’ for 401k employer deductions?

A

employee income, elective deferrals and catch up contributions of those employees

32
Q

How are employer contributions defined?

A

They are defined as nonelective contributions, matching contributions and discretionary profit sharing contributions

33
Q

For whom is a traditional 401k right for?

A
  • an employer wants to provide a qualified retirement plan but can afford only minimal contributions beyond salary
  • employees are relatively young
  • employers want to encourage employees to save for their own retirement.
34
Q

Another name for Auto Enrollment?

A

Negative election

35
Q

What does a negative election or auto enrollment do?

A

Allows an employer to enroll employees in a section 401k plan without the employees consent as long as the employees have a right to opt out of contributing.

36
Q

Qualified Automatic Contribution Arrangement

A

This is included in the pension protection act of 2006 that relieves this QACA from special nondiscrimination testing, with lower required employer contributions than under the current safe harbor 401k plan rules.

37
Q

What automatically qualifies with section 401k nondiscrimination testing?

A
  • provides an auto deferral percentage between 3-10% of employee compensation, if it’s less than 6%, there must be an increase each year until reaching 6%
  • employer contributions to non-HCE’s of either an employer match of 100% of first 1% plus 50% of next 5% or a 3% profit sharing contribution in lieu of the matching contribution
  • provides that the employer contributions are 100% vested after the employee has completed no more than 2 years of service
  • requires that, within 30 days prior to enrollment (and annually) eligible employees must be given a written automatic enrollment notice and a qualified default investment notice and allow the employees not to make any contributions, if they so choose.
38
Q

ADP and ACP tests

A

These are special nondiscrimination testing that apply to Traditional 401k plans

39
Q

Safe Harbor 401k Plan

A

Allows employers to have to comply with ADP and ACP testing because it permits a high level of elective deferrals by employees without annual discrimination testing.

40
Q

Safe Harbor 401k plan features

A
  • not subject to top heavy plan provisions.
  • subject to general discrimination tests, but not ADP and ACP
  • Mandatory minimum employer contributions are 100% vested immediately
41
Q

What are the mandatory minimum employer contributions?

A
  • nonelective contribution of 3% of compensation for all eligible employees
  • employer matching contribution of 100% on the first 3% of a non-HCE compensation plus a 50% match on the next 2% of a non HCE for those who are actually deferring salary into the plan.
  • the basic matching formula for HCEs must not exceed the rate of matching for non HCEs
42
Q

Actual Deferral Percentage Test (ADP) Definition

A

The employer must compare the average percentage of eligible HCEs pretax elective deferrals to the average percentage of the eligible non HCEs elective deferrals.

It only counts what employees are actually deferring into the plan on their own.

43
Q

Actual Contributions Percentage Test (ACP) Definition

A

follows the same procedure as the ADP tests but uses employer-matching contributions and employee after-tax contributions in the calculations.

44
Q

ADP Test Rules (2)

A

The ADP for eligible HCEs must not be more than the ADP of all other eligible employees multiplied by 1.25
OR
The ADP for eligible HCEs must not exceed the ADP for other eligible employees by more than 2% and the ADP for eligible HCEs must not be more than the ADP for all other eligible employees multiplied by 2

45
Q

When does the ACP test apply?

A

If the employer allows:

  • after-tax contributions
  • automatically contributes to all eligible plan participants
  • or matches the employee elective deferrals.
46
Q

SIMPLE 401(k)

A

The SIMPLE 401k is exempt from the special nondisrimination ACP and ADP tests that apply to the traditional 401k plan

47
Q

Features of a SIMPLE 401k

A

100 or fewer employers earning 5K or more, with a 2 year grace period for when they grow beyond 100 employees.

Employer may not maintain any other qualified or employer-sponsored plan, unless eligible for a 457 plan.

48
Q

Roth 401(k) Plan

A

Type of section 401k plan that has elective deferral contributions on an after-tax basis

49
Q

Roth 401k features

A
  • same contribution rates as traditional 401k
  • no phaseout for AGI like Roth IRA
  • only the employer matching contributions (if any) and the related earnings associated with a Roth 401k are taxable
  • same withdrawal rules as Roth IRA
50
Q

DAD Distribution

A

one of the qualifications of a Roth 401k distribution is that if they aren’t 59.5 Death, Age 59.5 and Disability are the only ways to get a qualified distribution from a Roth 401k

51
Q

One-Participant (Solo) 401k

A

a traditional 401k plan covering a business owner with no employees, or that person and their spouse.

52
Q

Solo 401k features

A
  • can make contributions to the plan both as a participant and as an employer
  • Limit of 20% contribute from the employer, not 25%
53
Q

Savings/Thrift Plan

A

Qualified defined contribution plan similar to a traditional profit-sharing plan except that it provides for and encourages after-tax employee contributions

54
Q

Keogh Plan

A

An employer sponsored retirement plan that covers one or more self-employed individuals, such as a sole proprietor or a partner.

55
Q

Different types of Keogh Plans

A
  • profit-sharing plan
  • money purchase plan
  • target benefit pension plan
56
Q

Whose considered self-employed for Keogh Plans?

A

Sole proprietor or partnership are considered self-employed.

57
Q

The two differences in a Keogh Plan

A
  • self-employed individuals must calculate their retirement plan contribution based on earned income, or net earnings from self-employment, instead of W-2 income
  • Self-employed individuals must use a net contribution rate in determining their allowable contribution to a Keogh defined contributions plan.

Course 5: Retirement Savings and Income Planning (7 decks)

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