PS and DC Plans

Question 1

What type of plan is a profit-sharing plan?

Answer 1

Defined contribution - contributions are not required because it is not a pension plan. Contributions come from profits, retained income, etc.

Question 2

What are the type of contributions that can be made to a profit-sharing plan?

Answer 2

In the name - profits (discretionary) and flexible annual (every 3 of 5 years) contributions

Question 3

What is the saver’s credit?

Answer 3

A non-refundable tax credit for up to $2000 for those who contribute to their retirement account, reduced by distributions from that account.

Exceptions, full-time students, those claimed on another tax filing, and has a phase-out

Question 4

What is a major advantage of any profit sharing plan?

Answer 4

In-service distributions. Most plans allow for hardship withdraws

Financial needs test: must be an immediate need
Resource test: participant must not have any other source to satisfy need

Question 5

In addition to the hardship test, what are the only reasons an in-service withdraw would be allowed? (My disastrously faulty emergency fund)

Answer 5

Payment of unreimbursed medical expenses
Federal distasters
Purchase of primary home
Payment of higher education expenses
Payment necessary to prevent foreclosure

Question 6

What is “My disastrously faulty emergency fund”?

Answer 6

M= medical
D= disaster
F= first home
E= education
F= foreclosure

Question 7

What is the result of early or hardship withdrawals from non-qualified distributions?

Answer 7

A 10% penalty on top of the ordinary income tax paid. The exception is for amounts over the 7.5% of AGI for medical.

Question 8

What are key characteristics of a profit sharing plan?

Answer 8

A DC plan, but not a pension plan - required contributions every 3 of 5 years
NOT covered by PBGC
Use when business has sporadic income
Use with a young workforce (time to save)
EEs take on the investment risk

Question 9

What is an age-weighted profit sharing plan?

Answer 9

Still a contribution plan - example of a cross-tested plan.

Each participants compensation is weighted by an age factor, skewing older employees (usually the owner) to a higher contribution factor without breaking nondiscrimination rules. It is tested on benefits, not contributions, which gives flexibility.

Still limited to 100%/$61k contribution

Question 10

What is a new comparability plan?

Answer 10

Another example of a cross-tested plan. Participants are divided into groups which can be based on a myriad of factors. Each group then gets a certain compensation benefit. Again, this does not break nondiscrimination if it satisfies 1 of 2 gateway rules:
-Each eligible non-HCE must receive 5%
-If not 5%, each non-HCE must receive at least 1/3 of the highest allocation compensation.

Question 11

What is a stock bonus plan?

Answer 11

A type of profit-sharing defined contribution plan where the ER contributes stocks instead of cash

Question 12

What is Net Unrealized Appreciation (NUA) and how is it taxed in a stock bonus plan?

Answer 12

NUA is the difference between cost basis and FMV at distribution. At distribution, the EE pays ordinary income tax on the basis. Upon selling stock, the EE pays long term capital gains on the NUA and depending on the holding period, either short or long term capital gains on any growth since distribution.

Question 13

What is an employee stock ownership plan (ESOP)?

Answer 13

An employee benefit plan that gives workers ownership interest in the company in the form of shares of stock.
ESOPs encourage employees to give their all as the company’s success translates into financial rewards.

Question 14

How does an EE “cash out” of an ESOP?

Answer 14

When a fully vested employee retires or resigns from the company, the firm “purchases” the vested shares back from them. The money goes to the employee in a lump sum or equal periodic payments, depending on the plan.

Once the company purchases the shares and pays the employee, the company redistributes or voids the shares. Employees who leave the company voluntarily cannot take the shares of stock with them, only the cash payment.

Question 15

What are disadvantages of an ESOP?

Answer 15

Cannot be integrated with SS
Lack of diversification (if this is all the EE has)

Question 16

What is a LESOP? (leveraged)

Answer 16

An ESOP that has bought out its owner’s shares using a loan and the ERs shares as collateral. The payment of that loan then frees up additional shares to contribute to EEs

Question 17

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

Answer 17

Traditional
SIMPLE
Roth
Safe harbor

Question 18

What are the characteristics of a traditional 401(k) plan?

Answer 18

AKA cash or deferred arrangement (CODA)

Qualified profit sharing or stock bonus plan under which participants have the option to contribute money on a pre-tax basis known as an elective deferral.

A 401(k) is an exception to the constructive receipt rule - the EE is not taxed on ER contributions until distribution

Question 19

How much can an ER deduct for 401(k) contributions?

Answer 19

Up to 25% of EE payroll

Question 20

What is an elective deferral?

Answer 20

Part of a 401(k) - the participants can elect to have a portion of their compensation put into the 401(k) on a pre-tax basis

Question 21

When is a 401(k) plan appropriate?

Answer 21

When the owner cannot afford much outside of existing salary (401(k) is funded by the EE salary)
EEs are young and have time
ERs want to encourage their EEs to save

Question 22

What is a negative election?

Answer 22

An automatic enrollment into an ERs company 401(k) as long as there is an option for the EE to opt-out

Question 23

What are 401(k) safe harbor rules?

Answer 23

Safe Harbor avoids compliance to special nondiscrimination testing which apply to traditional 401(k). It allows for a high level of EE deferrals and is not subject to top-heavy provisions. To qualify, an ER must contribute to a plan where the EE is 100% vested immediately, one of the following two ways:
-3% ER contribution
-100% match on 3%, 50% up to 5% (total 4% match to 5% EE contribution)

Question 24

What is the impact of the catch-up contributions on the maximum amount an EE or ER can contribute to a qualified plan?

Answer 24

There is no impact. The $6500 does not count against the contribution limit

Question 25

What is CODA?

Answer 25

Cash or deferred arrangement - do you want cash today or more cash later?

Question 26

A traditional 401(k) is subject to the ADP and ACP tests. What are those?

Answer 26

Actual deferral percentage: counts what EEs are actually deferring into their plan, comparing HCEs to non-HCEs as a way to encourage younger EEs to save. ADP for HCEs cannot be more than 1.25% than non-HCEs.

Actual contribution percentage: only difference is that it adds ER contributions to the EE deferral

Question 27

What are the ADP/ACP rules?

Answer 27

If ADP/ACP for non-HCE less then 2%, than the max for HCE is 2 x ADP/ACP of non-HCE
If ADP/ACP for non-HCE is between 2% and 8%, than the max for HCE is 2% + ADP/ACP of non-HCE
If ADP/ACP for non-HCE more than 8%, than the max for HCE is 1.25 x ADP/ACP of non-HCE

Question 28

What are the ER restrictions on setting up a savings incentive match plan for employees, or SIMPLE 401(k)?

Answer 28

Less than 100 EEs
The ER may not have another qualified or ER-sponsored plan. Exception: 457 or union plan

Question 29

What are the benefits and problems with the SIMPLE 401(k)?

Answer 29

Benefits
Exempt from ACP/ADP tests
Exempt from top-heavy testing
Can offer loans and hardship withdrawals

Problems
Less deferral allowance ($14k w/ $3k catch-up)

Question 30

What are characteristics of a ROTH 401(k)?

Answer 30

Separate account for the earnings (from traditional)
No phase-out limits (unlike the IRA)
Limit is still $20.5k for EE elections
Any loans are done without ordinary taxes because the tax has already been paid

Question 31

What is a qualified distribution for a ROTH 401(k)?

Answer 31

Requires two test met:
-Distribution is made after a 5-year period beginning on the first day of the taxable year of the first contribution.
-Distribution is made after the date the participant turns 59 1/2, is disabled, or dies.

Question 32

What kind of plan is a savings/thrift plan?

Answer 32

A DC plan, similar to a traditional profit sharing plan.
Encourages EE after-tax contributions w/ potential for ER matches

Question 33

What is a one-participant (solo) 401(k)?

Answer 33

Allows the owner to contribute as the EE and ER.
EE limits are still iaw 415
ER limits are 20%

Question 34

What is a Keogh (self-employed) plan?

Answer 34

A plan that covers 1 or more self-EEs that can be setup a any type of DB, DC, or tax-advantaged plan.
Most common are PS, money purchase, target - all DC plans.
Entity must be SE - no C or S corp

Question 35

How is the Keogh contribution and deduction calculated?

Answer 35

Schedule C income
Less SE tax paid (Income x .9235 x .0765)
Multiplied by contribution rate (max 20%)
=max deductible contribution

Question 36

What is the formula for determining the Keogh max contribution rate?

Answer 36

Plan contribution percentage / (1 + plan contribution percentage).

This percentage only applies to the owner as it serves to make the ER and EE contributions even

Question 37

What are QMACs and QNECs?

Answer 37

ER contributions or matches to non-HCE accounts in order to meet ADP/ACP tests.
EE Immediately vested as if they deferred the money